Financial Accounting 9th Edition Libby Solutions Manual

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Chapter 2 Investing and Financing Decisions and the Accounting System

ANSWERS TO QUESTIONS 1.

The primary objective of financial reporting for external users is to provide financial information about the reporting entity that is useful to existing and potential investors, lenders, and other creditors in making decisions about providing resources to the entity. These users are expected to have a reasonable understanding of accounting concepts and procedures. Usually, they are interested in information to assist them in projecting future cash inflows and outflows of a business.

2.

(a)

An asset is a probable future economic benefit owned or controlled by the entity as a result of past transactions.

(b)

A current asset is an asset that will be used or turned into cash within one year; inventory is always considered a current asset regardless of how long it takes to produce and sell the inventory.

(c)

A liability is a probable future sacrifice of economic benefits of the entity arising from preset obligations as a result of a past transaction.

(d)

A current liability is a liability that will be settled by providing cash, goods, or other services within the coming year.

(e)

Additional paid-in capital is the owner-provided financing to the business that represents the excess of the amount received when the common stock was issued over the par value of the common stock.

(f)

Retained earnings are the cumulative earnings of a company that are not distributed to the owners and are reinvested in the business.

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2-1

3.

(a)

The separate entity assumption requires that business transactions are separate from the transactions of the owners. For example, the purchase of a truck by the owner for personal use is not recorded as an asset of the business.

(b)

The monetary unit assumption requires information to be reported in the national monetary unit without any adjustment for changes in purchasing power. That means that each business will account for and report its financial results primarily in terms of the national monetary unit, such as Yen in Japan and Australian dollars in Australia.

(c)

Under the going-concern assumption, businesses are assumed to operate into the foreseeable future. That is, they are not expected to liquidate.

(d)

Historical cost is a measurement model that requires assets to be recorded at the cash-equivalent cost on the date of the transaction. Cashequivalent cost is the cash paid plus the dollar value of all noncash considerations.

4.

Accounting assumptions are necessary because they reflect the scope of accounting and the expectations that set certain limits on the way accounting information is reported.

5.

An account is a standardized format used by organizations to accumulate the dollar effects of transactions on each financial statement item. Accounts are necessary to keep track of all increases and decreases in the fundamental accounting model.

6.

The fundamental accounting model is provided by the equation: Assets = Liabilities + Stockholders' Equity

7.

A business transaction is (a) an exchange of resources (assets) and obligations (debts) between a business and one or more outside parties, and (b) certain events that directly affect the entity such as the use over time of rent that was paid prior to occupying space and the wearing out of equipment used to operate the business. An example of the first situation is (a) the sale of goods or services. An example of the second situation is (b) the use of insurance paid prior to coverage.

8.

Debit is the left side of a T-account and credit is the right side of a T-account. A debit is an increase in assets and a decrease in liabilities and stockholders' equity. A credit is the opposite -- a decrease in assets and an increase in liabilities and stockholders' equity.

2-2

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9.

Transaction analysis is the process of studying a transaction to determine its economic effect on the entity in terms of the accounting equation: Assets = Liabilities + Stockholders' Equity The two principles underlying the process are: * every transaction affects at least two accounts. * the accounting equation must remain in balance after each transaction.

The two steps in transaction analysis are: (1) identify and classify accounts and the direction and amount of the effects.

(2) determine that the accounting equation (A = L + SE) remains in balance.

10.

The equalities in accounting are: (a) Assets = Liabilities + Stockholders' Equity (b) Debits = Credits

11.

The journal entry is a method for expressing the effects of a transaction on accounts in a debits-equal-credits format. The title of the account(s) to be debited is (are) listed first and the title of the account(s) to be credited is (are) listed underneath the debited accounts. The debited amounts are placed in a left-hand column and the credited amounts are placed in a right-hand column.

12.

The T-account is a tool for summarizing transaction effects for each account, determining balances, and drawing inferences about a company's activities. It is a simplified representation of a ledger account with a debit column on the left and a credit column on the right.

13.

The current ratio is computed as current assets divided by current liabilities. It measures the ability of the company to pay its short-term obligations with current assets. A ratio above 1.0 normally suggests good liquidity (that is, the company has sufficient current assets to settle short-term obligations). Sophisticated cash management systems allow many companies to minimize funds invested in current assets and have a current ratio below 1.0. However, a ratio that is too high in relation to other competitors in the industry may indicate inefficient use of resources.

14.

Investing activities on the statement of cash flows include the buying and selling of productive assets and investments. Financing activities include borrowing and repaying debt, issuing and repurchasing stock, and paying dividends.

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2-3

MULTIPLE CHOICE 1.

2.

3.

4.

5.

2-4

d d a a d

6.

7.

8.

9.

10.

c a d b a

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(Time in minutes)

Mini-exercises No. Time 1 3 2 3 3 4 4 4 5 5 6 3 7 3 8 6 9 6 10 6 11 6 12 4 13 4

Exercises No. Time 1 8 2 15 3 8 4 10 5 10 6 10 7 10 8 15 9 20 10 20 11 20 12 20 13 20 14 20 15 20 16 20 17 20 18 10 19 10 20 10 21 10 22 15

Problems No. Time 1 20 2 25 3 40 4 15 5 40 6 20

Alternate Problems No. Time 1 20 2 25 3 40 4 15

Cases and Projects No. Time 1 15 2 15 3 15 4 20 5 15 6 20 7 30 8 20 9 *

Continuing Problem 1

40

* Due to the nature of these cases and projects, it is very difficult to estimate the amount of time students will need to complete the assignment. As with any open-ended project, it is possible for students to devote a large amount of time to these assignments. While students often benefit from the extra effort, we find that some become frustrated by the perceived difficulty of the task. You can reduce student frustration and anxiety by making your expectations clear. For example, when our goal is to sharpen research skills, we devote class time discussing research strategies.

When we want the students to focus on a real accounting issue, we offer suggestions about possible companies or industries.

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2-5

MINI-EXERCISES M2–1.

F

(1) Going concern assumption

H

(2) Historical cost

G

(3) Credits

A

(4) Assets

I

(5) Account

M2–2.

D

(1) Journal entry

C

(2) A = L + SE, and Debits = Credits

A

(3) Assets = Liabilities + Stockholders’ Equity

I

(4) Liabilities

B

(5) Income statement, balance sheet, statement of stockholders’ equity, and statement of cash flows

M2–3.

(1) N (2) N (3) Y (4) Y (5) Y (6) N

2-6

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M2–4.

CL

(1) Accounts Payable

CA

(2) Accounts Receivable

NCA

(3) Buildings

CA

(4) Cash

SE

(5) Common Stock

NCA

(6) Land

CA

(7) Merchandise Inventory

CL

(8) Income Taxes Payable

NCA

(9) Long-Term Investments

NCL

(10) Notes Payable (due in three years)

CA

(11) Notes Receivable (due in six months)

CA

(12) Prepaid Rent

SE

(13) Retained Earnings

CA

(14) Supplies

CL

(15) Utilities Payable

CL

(16) Wages Payable

M2–5.

Assets

=

a.

Cash

+30,000

b.

Cash Notes receivable

–10,000 +10,000

c.

Cash

Liabilities

+ Stockholders’ Equity

Notes payable +30,000

+500

Common stock Additional paid-in capital

d.

Cash Equipment

e.

Cash

–5,000 +15,000 –2,000

+10

+490

Notes payable +10,000 Retained earnings

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–2,000

2-7

M2–6.

Debit

Credit

Assets

Increases

Decreases

Liabilities

Decreases

Increases

Stockholders’ equity

Decreases

Increases

Increase

Decrease

Assets

Debit

Credit

Liabilities

Credit

Debit

Stockholders’ equity

Credit

Debit

M2–7.

M2–8. a.

b.

c.

d.

e.

2-8

Cash (+A) ............................................................................

Notes Payable (+L) ........................................................

30,000

Notes Receivable (+A).........................................................

Cash (A) .......................................................................

10,000

Cash (+A) ............................................................................

Common Stock (+SE) ....................................................

Additional Paid-in Capital (+SE)………………………….

500

Equipment (+A) ...................................................................

Cash (A) .......................................................................

Notes Payable (+L) ........................................................

15,000

Retained Earnings (SE) .....................................................

Cash (A) .......................................................................

2,000

30,000

10,000

10 490

5,000 10,000

2,000

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M2–9.

Cash Beg. 900 (a) 30,000 10,000 (c) 500 5,000 2,000 14,400

(b) (d) (e)

Notes Receivable Beg. 1,000 (b) 10,000

11,000

Equipment Beg. 15,100 (d) 15,000

30,100

Notes Payable 3,000 Beg. 30,000 (a) 10,000 (d) 43,000 Common Stock 1,000 Beg. 10 (c) 1,010

Additional Paid-in Capital

3,000 Beg. 490 (c) 3,490

Retained Earnings 10,000 Beg. (e) 2,000 8,000

M2-10.

Dennen, Inc. Trial Balance January 31 Cash Notes receivable Equipment Notes payable Common stock Additional paid-in capital Retained earnings Totals

Debit $14,400 11,000 30,100

Credit

$43,000 1,010 3,490 8,000 $55,500

$55,500

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2-9

M2–11.

Dennen Inc. Balance Sheet At January 31 Assets Current assets: Cash Notes receivable Total current assets Equipment

Total Assets

$ 14,400 11,000 25,400 30,100

$55,500

Liabilities Current liabilities: Notes payable Total current liabilities Stockholders’ Equity Common stock Additional paid-in capital Retained earnings Total stockholders’ equity Total Liabilities & Stockholders’ Equity

$ 43,000 43,000 1,010 3,490 8,000 12,500 $55,500

M2–12.

Current Ratio = Current Assets 280,000 270,000

2013 2014

÷ ÷ ÷

Current Liabilities 155,000 250,000

= =

1.806 1.080

This ratio indicates that Sal’s Taco Company has sufficient current assets to settle current liabilities, but that the ratio has also decreased between 2013 and 2014 by .726 (40%). Sal’s Taco Company ratio is lower than Chipotle’s 2014 ratio (of 3.576), indicating that Sal’s Taco Company appears to have weaker liquidity than Chipotle; Sal’s has less liquidity to withstand an economic downturn.

M2–13. (a) F (b) I (c) F (d) I (e) F 2-10

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EXERCISES

E2–1.

E

(1) Transaction

F

(2) Going concern assumption

B

(3) Balance sheet

P

(4) Liabilities

K

(5) Assets = Liabilities + Stockholders’ Equity

M

(6) Notes payable

L

(7) Common stock

H

(8) Historical cost

I

(9) Account

Q

(10) Dual effects

O

(11) Retained earnings

A

(12) Current assets

C

(13) Separate entity assumption

X

(14) Par value

D

(15) Debits

J

(16) Accounts receivable

N

(17) Monetary unit assumption

W

(18) Faithful representation

T

(19) Relevance

R

(20) Stockholders’ Equity

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2-11

E2–2.

Req. 1 Received

Given

(a)

Cash (A)

Common stock and Additional paid-in capital (SE)

(b)

Equipment (A)

(c)

No exchange transaction

—

(d)

Equipment (A)

Notes payable (L)

(e)

Building (A)

(f)

Intangibles (A)

(g)

Retained earnings (SE) [Received a reduction Dividends payable (L) in the amount available for payment to stockholders]

(h)

Land (A)

(i)

Intangibles (A)

(j)

No exchange transaction

—

(k)

Investments (A)

Cash (A)

(l)

Cash (A)

Short-term notes payable (L)

(m)

Note payable (L) promise to pay]

[or Delivery truck] [or Computer equipment]

[or Construction in progress] [or Copyright]

Cash (A)

Cash (A) Cash (A)

Cash (A) [or Patents]

[Received a reduction in its

Cash (A) and Notes payable (L)

Cash (A)

Req. 2 The truck in (b) would be recorded as an asset of $18,000. The land in (h) would be recorded as an asset of $50,000. These are applications of the historical cost principle.

Req. 3 The agreement in (c) involves no exchange or receipt of cash, goods, or services and thus is not a transaction. Since transaction (j) occurs between the owner and others, there is no effect on the business because of the separate-entity assumption.

2-12

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E2–3.

Balance Sheet Categorization

Debit or Credit Balance

(1) Accounts Receivable

CA

Debit

(2) Retained Earnings

SE

Credit

(3) Accrued Expenses Payable

CL

Credit

(4) Prepaid Expenses

CA

Debit

(5) Common Stock

SE

Credit

(6) Long-Term Investments

NCA

Debit

(7) Plant, Property, and Equipment

NCA

Debit

(8) Accounts Payable

CL

Credit

(9) Short-Term Investments

CA

Debit

NCL

Credit

Account

(10) Long-Term Debt

E2–4.

Event a.

Assets Cash

=

+ Stockholders’ Equity

Liabilities

+40,000

Common stock Additional paid-in capital

b.

Equipment

+15,000

Cash

–3,000

c.

Cash

+10,000

d.

Note receivable

+800

Cash

–800

Land

+13,000

Cash

–4,000

e.

Accounts payable

+12,000

Notes payable

+10,000

Mortgage notes payable

+9,000

Financial Accounting, 9/e © 2017 by McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

+1,000 +39,000

2-13

E2–5.

Req. 1 Event Assets a.

Buildings Equipment Cash b.

Cash

= +172 +270 – 432

Liabilities Notes payable (long-term)

+

Stockholders’ Equity

+10

+345

Common stock Additional paid-in capital

+200 +145

c. d.

Dividends payable Short-term Investments Cash

e.

No effects

f.

Cash Short-term Investments

+145

Retained earnings

–145

+7,616 -7,616 +4,313 –4,313

Req. 2 The separate entity assumption states that transactions of the business are separate from transactions of the owners. Since transaction (e) occurs between the owners and others in the stock market, there is no effect on the business.

2-14

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E2–6. a.

b.

c.

d.

e.

Cash (+A) ............................................................................

Common stock (+SE)*....................................................

Additional paid-in capital (+SE) …………………………...

40,000

Equipment (+A) ...................................................................

Cash (A) .......................................................................

Accounts payable (+L) ..................................................

15,000

Cash (+A) ............................................................................

Notes payable (+L) .........................................................

10,000

Notes receivable (+A) .........................................................

Cash (A) ......................................................................

800

Land (+A).............................................................................

Cash (A) .......................................................................

Mortgage notes payable (+L) ........................................

13,000

1,000 39,000

3,000 12,000

10,000

800

4,000 9,000

*Common stock at par value: 1,000 shares x $1 par value = $1,000 Additional paid-in capital is the excess over market: 1,000 shares x $39 excess = $39,000

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2-15

E2–7.

Req. 1 a.

b.

c.

d.

Buildings (+A) ......................................................................

Equipment (+A) ..................................................................

Cash (A) .......................................................................

Notes payable (+L) ........................................................

172 270

Cash (+A) ............................................................................

Common stock (+SE) .....................................................

Additional paid-in capital (+SE)

345

Retained earnings (SE) .....................................................

Dividends payable (+L) ..................................................

145

Short-term investments (+A)................................................

Cash (A) .......................................................................

7,616

e.

No journal entry required.

f.

Cash (+A) ............................................................................

Short-term investments (A) ..........................................

432 10

200 145

145

7,616

4,313 4,313

Req. 2 The separate entity assumption states that transactions of the business are separate from transactions of the owners. Since transaction (e) occurs between the owners and others in the stock market, there is no effect on the business.

2-16

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E2–8.

Req. 1 a.

b.

c.

d.

e.

f.

g.

Cash (+A) ...........................................................................

Notes payable (+L) .......................................................

30,000

Cash (+A) (500 shares x $30 market value per share) ........

Common stock (+SE) (500 shares x $0.10 par value)....

Additional paid-in capital (+SE) (difference) ...................

15,000

Buildings (+A) ......................................................................

Cash (A) .......................................................................

Notes payable (+L) ........................................................

115,000

Equipment (+A) ...................................................................

Cash (A) ......................................................................

Accounts payable (+L) ..................................................

20,000

Notes receivable (+A) ..........................................................

Cash (A) .......................................................................

1,000

Accounts payable (L) .........................................................

Cash (A) .......................................................................

2,000

Short-term investments (+A)................................................

Cash (A) .......................................................................

10,000

30,000

50 14,950

23,000 92,000

4,000 16,000

1,000

2,000

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10,000

2-17

E2–9.

Req. 1 Cash Beg. 0 (a) 70,000 4,500 (b) (d) 3,000 2,500 (e) 66,000 Land Beg. 0 (d) 15,000

Notes Receivable Beg. 0 (e) 2,500 2,500

18,000

Notes Payable 0 Beg. 13,500 (b)

15,000

Equipment Beg. 0 (b) 18,000

13,500

Common Stock 0 Beg. 5,040 (a)* 100 (d) 5,140

Additional Paid-in Capital

0 Beg. 64,960 (a) 17,900 (d) 82,860 *6 investors x 8,400 shares each = 50,400 shares issued 50,400 shares issued x $0.10 par value per share = $5,040 for common stock

Req. 2 Assets $

101,500

= Liabilities $ 13,500

+ Stockholders’ Equity $

88,000

Req. 3 The agreement in (c) involves no exchange or receipt of cash, goods, or services and thus is not a transaction. Since transaction (f) occurs between the owner and others, there is no effect on the business due to the separate-entity assumption.

2-18

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E2–10.

Req. 1 Cash Beg. 0 (a) 60,000 9,000 (b) 2,500 (c) 12,000 (e) 36,500 Land Beg. 0 (a) 35,000

Notes Receivable Beg. 0 (c) 2,500

2,500

(e)

35,000

Equipment Beg. 0 (b) 36,000

36,000

Notes Payable 0 Beg. 12,000 27,000 (b)

Common Stock 0 Beg. 300 (a)*

15,000

300

Additional Paid-in Capital

0 Beg. 94,700 (a)* 94,700 * Common Stock: 3 investors x 1,000 shares each = 3,000 shares issued 3,000 shares issued x $0.10 par value per share = $300 for common stock Additional Paid-in Capital: $95,000 received - $300 par value = $94,700

Req. 2 Assets $

110,000

= Liabilities $ 15,000

+ Stockholders’ Equity $

95,000

Req. 3 Since transaction (d) is a personal purchase, not purchased by Precision Builders, there is no effect on the business due to the separate entity assumption.

Req. 4 Market value per share = total received ÷ number of shares issued = $95,000 ÷ 3,000 shares issued = $31.67 per share Financial Accounting, 9/e © 2017 by McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

2-19

E2–11.

Req. 1 Transaction 1

Brief Explanation Issued common stock to shareholders for $15,000 cash. (FastTrack Sports Inc. is a corporation because it issues stock. Par value of the stock was $0.10 per share because $1,500 common stock amount divided by 15,000 shares issued equals $0.10 per share).

2

Borrowed $75,000 cash and signed a short-term note for this amount.

3

Purchased land for $16,000; paid $5,000 cash and gave an $11,000 short-term note payable for the balance.

4

Loaned $4,000 cash; borrower signed a short-term note for this amount (Note Receivable).

5

Purchased store fixtures for $9,500 cash.

6

Purchased land for $4,000, paid for by signing a short-term note.

Req. 2 FastTrack Sports Inc. Balance Sheet At January 7 Assets Current Assets Cash Note receivable Total Current Assets

$71,500 4,000 75,500

Store fixtures Land

9,500 20,000

Total Assets

$105,000

2-20

Liabilities Current Liabilities Note payable Total Current Liabilities

$90,000 90,000

Stockholders’ Equity Common stock Additional paid-in capital Total Stockholders’ Equity Total Liabilities & Stockholders’ Equity

1,500 13,500 15,000 $105,000

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E2–12.

Req. 1 Transaction 1

Brief Explanation Issued common stock to shareholders for $45,000 cash. (Volz Cleaning is a corporation because it issues stock. Par value is $2.00 per share $6,000 common stock amount divided by 3,000 shares issued equals $2.00 per share).

2

Purchased a delivery truck for $35,000; paid $8,000 cash and gave a $27,000 long-term note payable for the balance.

3

Loaned $2,000 cash; borrower signed a short-term note for this amount.

4

Purchased short-term investments for $7,000 cash.

5

Sold short-term investments at cost for $3,000 cash.

6

Purchased computer equipment for $4,000 cash.

Req. 2 Volz Cleaning, Inc. Balance Sheet At March 31 Assets Current Assets Cash Investments Note receivable Total Current Assets Computer equipment Delivery truck Total Assets

$27,000 4,000 2,000 33,000 4,000 35,000 $72,000

Liabilities Notes payable Total Liabilities Stockholders’ Equity Common stock Additional paid-in capital Total Stockholders’ Equity Total Liabilities & Stockholders’ Equity

Financial Accounting, 9/e © 2017 by McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

$27,000 27,000

6,000 39,000 45,000 $72,000

2-21

E2–13. a.

Cash (+A) ............................................................................

Common stock (+SE) .....................................................

Additional paid-in capital (+SE)…………………………..

70,000 5,000 65,000

b.

No transaction has occurred because there has been no exchange or receipt of cash, goods, or services.

c.

Cash (+A) ............................................................................

Notes payable (long-term) (+L) ......................................

18,000

Equipment (+A) ...................................................................

Cash (A) .......................................................................

Notes payable (short-term) (+L) .....................................

11,000

Notes receivable (short-term) (+A) ......................................

Cash (A) .......................................................................

2,000

Store fixtures (+A) ...............................................................

Cash (A) .......................................................................

15,000

d.

e.

f.

2-22

18,000

1,500 9,500

2,000

15,000

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E2–14. a.

Retained earnings (SE) .....................................................

Dividends payable (+L) ..................................................

1,508 1,508

b.

No transaction has occurred because there has been no exchange or receipt of cash, goods, or services.

c.

Dividends payable (L) ........................................................

Cash (A) .......................................................................

852

Cash (+A) ............................................................................

Notes payable (+L) .........................................................

5,899

Cash (+A) ............................................................................

Equipment (A) ..............................................................

53

Equipment (+A) ...................................................................

Cash (A) .......................................................................

Notes payable (+L) ........................................................

2,598

Investments (+A) .................................................................

Cash (A) .......................................................................

2,616

d.

e.

f.

g.

852

5,899

53

2,250 348

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2,616

2-23

E2–15.

Req. 1 Assets $

10,500

= Liabilities $

3,000

+ Stockholders’ Equity $

7,500

Req. 2 Cash Beg. 5,000 (a) 4,000 (b) 1,500 (c) 1,500 800 (d) End. 11,200

Short-Term Investments Beg. 2,500 1,500 (b)

Property & Equipment Beg. 3,000 1,500 (c)

End.

End.

Short-Term Notes Payable 2,200 Beg.

Additional Paid-in Capital

4,000 Beg.

500

Req. 3 Assets $

13,700

1,500

Long-Term Notes Payable 800 Beg. 4,000 (a) 4,800 End.

2,200 End. Common Stock 500 Beg.

1,000

4,000

= Liabilities $

7,000

Retained Earnings 3,000 Beg. (d) 800 2,200

+ Stockholders’ Equity $

6,700

Req. 4 Current Ratio

=

Current Assets Current Liabilities

=

$11,200+$1,000 $2,200

=

$12,200 = 5.55 $2,200

This ratio indicates that, for every $1 of current liabilities, Higgins maintains $5.55 of current assets. Higgins’ ratio is higher than the industry average of 1.50, indicating that Higgins maintains a lower level of short-term debt and has higher liquidity. However, maintaining such a high current ratio also suggests that the company may not be using its resources efficiently. Increasing short-term obligations would lower Higgins’ current ratio, but this strategy alone would not help its efficiency. Higgins should consider investing more of its cash in order to generate future returns.

2-24

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E2–16.

Higgins Company Balance Sheet At December 31 Assets Current Assets Cash Short-term investments Total Current Assets

Property and equipment

$ 11,200 1,000 12,200

1,500

$13,700

Total Assets

Liabilities Current Liabilities Short-term notes payable Total Current Liabilities Long-term notes payable Total Liabilities Stockholders’ Equity Common stock Additional paid-in capital Retained earnings Total Stockholders’ Equity Total Liabilities & Stockholders’ Equity

$ 2,200 2,200 4,800 7,000 500 4,000 2,200 6,700 $13,700

E2–17.

Req. 1

Cash Beg. 0 (a) 40,000 4,000 (c) 1,000 (d) 35,000

Equipment Beg. 0 (c) 20,000 (d) 1,000 21,000 Common Stock 0 Beg. 10,000 (a) 10,000

Short-Term Notes Receivable Beg. 0 (e) 4,000 4,000

Land Beg. 0 (b) 16,000 4,000 (e) 12,000

Short-Term Notes Payable 0 Beg. 16,000 (b) 16,000

Long-Term Notes Payable 0 Beg. 16,000 (c) 16,000

Additional Paid-in Capital

0 Beg. 30,000 (a) 30,000

Financial Accounting, 9/e © 2017 by McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

2-25

E2–17. (continued) Req. 2 Strauderman Delivery Company, Inc. Trial Balance December 31, 2016 Cash Short-term notes receivable Land Equipment Short-term notes payable Long-term notes payable Common stock Additional paid-in capital Totals

2-26

Debit $35,000 4,000 12,000 21,000

$72,000

Credit

$16,000 16,000 10,000 30,000 $72,000

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E2–17. (continued) Req. 3 Strauderman Delivery Company, Inc. Balance Sheet At December 31, 2016 Assets Current Assets Cash Short-term note receivable Total Current Assets

$35,000 4,000 39,000

Land Equipment

12,000 21,000

$72,000

Total Assets

Liabilities Current Liabilities Short-term notes payable Total Current Liabilities Long-term notes payable Total Liabilities Stockholders’ Equity Common stock Additional paid-in capital Total Stockholders’ Equity Total Liabilities & Stockholders’ Equity

$16,000 16,000 16,000 32,000

10,000 30,000 40,000 $72,000

Req. 4 2016

Current Assets $39,000

÷ ÷

Current Liabilities $16,000

= =

Current Ratio 2.44

2017

52,000

÷

23,000

=

2.26

2018

47,000

÷

40,000

=

1.18

The current ratio has decreased over the years, suggesting that the company’s liquidity is decreasing. Although the company still maintains sufficient current assets to settle the short-term obligations, this steep decline in the ratio may be of concern – it may be indicative of more efficient use of resources or it may suggest the company is having cash flow problems.

Req. 5 The management of Strauderman Delivery Company has already been financing the company’s development through additional short-term debt, from $16,000 in 2016 to $40,000 in 2018. This suggests the company is taking on increasing risk. Additional lending, particularly short-term, to the company may be too much risk for the bank to absorb. Based solely on the current ratio, the bank’s vice president should consider not providing the loan to the company as it currently stands. Of course, additional analysis would provide better information for making a sound decision.

Financial Accounting, 9/e © 2017 by McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

2-27

E2–18.

Transaction

Brief Explanation

(a)

Issued 100,000 shares of common stock (par value $0.02 per share) to shareholders in exchange for $20,000 cash and $5,000 tools and equipment.

(b)

Loaned $1,800 cash; borrower signed a note receivable for this amount.

(c)

Purchased a building for $40,000; paid $10,000 cash and signed a $30,000 note payable for the balance.

(d)

Sold tools and equipment for $900 cash (their original cost).

E2–19.

Req. 1 Increases with…

Decreases with…

Equipment

Purchases of equipment

Sales of equipment

Notes receivable

Additional loans to others

Collection of loans

Notes payable

Additional borrowings

Payments of debt

Req. 2 Equipment 1/1

500 250

12/31

Notes Receivable 1/1

150

650

100 1/1 225

245

100

Notes Payable

12/31

170

110

170

160 12/31

Beginning balance $500

+

―+‖



―‖

=

+

250



? ?

= =

Ending balance $100 650

Notes receivable

150

+

?



225 ?

= =

170 245

Notes payable

100

+

170



? ?

= =

160 110

Equipment

2-28

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E2–20.

Activity (a) (b) (c) (d) (e) (f)

Capital expenditures (for property, plant, and equipment) Repurchases of common stock from investors Sale of short-term investments Issuance of common stock Purchases of short-term investments Dividends paid on common stock.

Type of Activity I F I F I F

Effect on Cash   + +  

Type of Activity F I I F I F F I

Effect on Cash +  + +    +

E2–21.

Activity (a) (b) (c) (d) (e) (f) (g) (h)

Additional borrowing from banks Purchase of investments Sale of assets and investments (assume sold at cost) Issuance of stock Purchases of property, plant, and equipment Payment of debt principal Dividends paid Receipt of principal payment on a note receivable

E2–22.

1. Current assets

In the asset section of a classified balance sheet.

2. Debt principal repaid

In the financing activities section of the statement of cash flows.

3. Significant accounting policies

Usually the first note after the financial statements.

4. Cash received on sale of noncurrent assets

In the investing activities section of the statement of cash flows.

5. Dividends paid

In the financing activities section of the statement of cash flows.

6. Short-term obligations

In the current liabilities section of a classified balance sheet.

7. Date of the statement of financial position.

In the heading of the balance sheet.

Financial Accounting, 9/e © 2017 by McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

2-29

PROBLEMS P2–1.

2-30

Balance Sheet Classification

Debit or Credit Balance

(1)

Notes and Loans Payable (short-term)

CL

Credit

(2)

Materials and Supplies

CA

Debit

(3)

Common Stock

SE

Credit

(4)

Patents (an intangible asset)

NCA

Debit

(5)

Income Taxes Payable

CL

Credit

(6)

Long-Term Debt

NCL

Credit

(7)

Marketable Securities (short-term)

CA

Debit

(8)

Property, Plant, and Equipment

NCA

Debit

(9)

Retained Earnings

SE

Credit

(10)

Notes and Accounts Receivable (short-term)

CA

Debit

(11)

Investments (long-term)

NCA

Debit

(12)

Cash and Cash Equivalents

CA

Debit

(13)

Accounts Payable

CL

Credit

(14)

Crude Oil Products and Merchandise

CA

Debit

(15)

Additional Paid-in Capital

SE

Credit

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P2–2.

Req. 1 East Hill Home Healthcare Services was organized as a corporation. Only a corporation issues shares of capital stock to its owners in exchange for their investment, as in transaction (a).

Req. 2 (On next page)

Req. 3 The transaction between the two stockholders (Event e) was not included in the tabulation. Since the transaction in (e) occurs between the owners, there is no effect on the business due to the separate-entity assumption.

Req. 4 (a)

Total assets = $111,500 + $18,000 + $5,000 + $510,500 + $160,000 + $65,000 = $870,000

(b)

Total liabilities = $100,000 + $180,000 = $280,000

(c)

Total stockholders’ equity = Total assets – Total liabilities = $870,000 – $280,000 = $590,000

(d)

Cash balance = $50,000 + $90,000 – $9,000 + $3,500 – $18,000 – $5,000 = $111,500

(e)

Total current assets = Cash $111,500 + Short-Term Investments $18,000 + Notes Receivable $5,000 = $134,500

Req. 5

Current Ratio

=

Current Assets Current Liabilities

= $111,500+$18,000+$5,000 = $134,500 = 1.35 $100,000 100,000

This suggests that for every $1 in current liabilities, East Hill maintains $1.35 in current assets. The ratio suggests that East Hill is likely maintaining adequate liquidity and using resources efficiently.

Financial Accounting, 9/e © 2017 by McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

2-31

P2–2. (continued) Req. 2 Assets

Cash

Short-Term Notes Investments Receivable

=

Liabilities

ST Notes LT Notes Land Buildings Equipment Payable Payable 500,000 100,000 50,000 = 100,000 100,000

Beg.

50,000

(a)

+90,000

(b)

–9,000

+14,000

(c)

+3,500

–3,500

(d)

–18,000

= +60,000

+18,000

+

Stockholders' Equity Additional Common Paid-in Retained Capital Earnings Stock 20,000 80,000 400,000 +9,000

+15,000 =

+81,000

+80,000

= =

(e) No effect –5,000

(f)

+111,500

+5,000 +18,000

+5,000 +510,500 +160,000

$870,000

2-32

= +65,000 = +100,000

+180,000

$280,000

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+29,000

+161,000 +400,000

$590,000

P2–3.

Req. 1 and 2

Beg. (e) (f) (i)

Cash 22,000 11,000 10,000 (a) 9,000 5,000 (b) 1,000 5,000 (c) 3,000 (g) 8,000 (h)

Investments (short-term) Beg. 3,000 (a) 10,000 13,000

Beg.

12,000

Accounts Receivable Beg. 3,000

3,000

Inventory 20,000

Notes Receivable (long-term) Beg. 1,000 (b) 5,000

20,000

6,000

Beg. (c)

Equipment 50,000 18,000 1,000 (i)

Factory Building Beg. 90,000 (h) 24,000

Beg. (g)

Intangibles 5,000 3,000

End.

67,000

End. 114,000

End.

8,000

Accrued Liabilities Payable 4,000 Beg.

Notes Payable (short-term) 7,000 Beg. 13,000 (c) 9,000 (f) 29,000

Accounts Payable 15,000 Beg.

15,000

Long-Term Notes Payable 47,000 Beg. 16,000 (h) 63,000

4,000

Common Stock 10,000 Beg. 1,000 (e)

Additional Paid-in Capital 80,000 Beg. 10,000 (e)

11,000

90,000

Retained Earnings 31,000 Beg.

31,000

Financial Accounting, 9/e © 2017 by McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

2-33

P2–3. (continued) Req. 3 No effect was recorded for (d). The agreement in (d) involves no exchange or receipt of cash, goods, or services and thus is not a transaction.

Req. 4

Cougar Plastics Company Trial Balance At December 31

Cash Investments (short-term) Accounts receivable Inventory Notes receivable (long-term) Equipment Factory building Intangibles Accounts payable Accrued liabilities payable Notes payable (short-term) Notes payable (long-term) Common stock Additional paid-in capital Retained earnings Totals

2-34

Debit $ 12,000 13,000 3,000 20,000 6,000 67,000 114,000 8,000

$243,000

Credit

$ 15,000 4,000 29,000 63,000 11,000 90,000 31,000 $243,000

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P2–3. (continued) Req. 5 Cougar Plastics Company Balance Sheet At December 31 Assets Current Assets Cash Investments Accounts receivable Inventory Total Current Assets

$ 12,000 13,000 3,000 20,000 48,000

Notes receivable Equipment Factory building Intangibles

6,000 67,000 114,000 8,000

$243,000

Total Assets

Liabilities Current Liabilities Accounts payable Accrued liabilities payable Notes payable Total Current Liabilities Long-term notes payable Total Liabilities Stockholders’ Equity Common stock Additional paid-in capital Retained earnings Total Stockholders’ Equity Total Liabilities & Stockholders’ Equity

$ 15,000 4,000 29,000 48,000 63,000 111,000

11,000 90,000 31,000 132,000 $243,000

Req. 6 Current Ratio

=

Current Assets Current Liabilities

=

$48,000 = 1.00 $48,000

This ratio indicates that Cougar Plastics has relatively low liquidity; for every $1 of current liabilities, Cougar Plastics maintains only $1 of current assets.

Financial Accounting, 9/e © 2017 by McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

2-35

P2–4.

Transaction

Type of Activity

Effect on Cash

(a) (b) (c) (d) (e) (f) (g) (h) (i)

I I I NE F F I I I

– – – NE + + – – +

P2–5.

Req. 1 a.

b.

c.

d.

e.

f.

2-36

Cash (+A) ............................................................................

Long-term debt (+L) .......................................................

18,266

Long-term investments (+A) ................................................

Short-term investments (+A) ...............................................

Cash (A) .......................................................................

4,200 16,800

Property, plant, and equipment (+A) ....................................

Cash (A) .......................................................................

Short-term notes payable (+L) .......................................

10,981

Cash (+A) ............................................................................

Common stock (+SE) .....................................................

Additional paid-in capital (+SE) ......................................

1,469

Cash (+A) ............................................................................

Short-term investments (A) ..........................................

18,810

Retained earnings (SE) .....................................................

Dividends payable (+L) ..................................................

11,126

18,266

21,000

9,571 1,410

1 1,468

18,810

11,126

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P2–5. (continued) Req. 2

Beg. (a) (d) (e)

Cash 13,844 18,266 21,000 (b) 1,469 9,571 (c) 18,810 21,818

Beg. (b)

Beg.

Long-Term Investments Beg. 130,162 (b) 4,200 134,362

Short-Term Investments 11,233 16,800 18,810 (e) 9,223

Inventories 2,111 2,111

Property, Plant, and Equipment Beg. 20,624 (c) 10,981 31,605

Accounts Payable 30,196 Beg. 30,196 Short-term Notes Payable 6,308 1,410 (c) 7,718

Long-term Debt 28,987 Beg. 18,266 (a) 47,253

Common Stock 1 Beg 1 (d) 2

Accounts Receivable Beg. 17,460 17,460

Other Current Assets Beg. 23,883 23,883 Other Noncurrent Assets Beg. 12,522 12,522

Accrued Expenses 18,453 Beg. 18,453

Unearned Revenue 8,491 Beg. 8,491

Dividends Payable 0 Beg. 11,126 (f) 11,126 Other Noncurrent Liabilities 27,857 Beg. 27,857

Additional Paid-in Capital 23,312 Beg. 1,468 (d) 24,780

(f)

Retained Earnings 88,234 Beg. 11,126 77,108

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2-37

P2–5. (continued) Req. 3 Apple, Inc. Balance Sheet At September 26, 2015 (in millions) ASSETS Current Assets: Cash Short-term investments Accounts receivable Inventories Other current assets Total current assets Long-term investments Property, plant and equipment Other noncurrent assets Total assets LIABILITIES AND STOCKHOLDERS’ EQUITY Current Liabilities: Accounts payable Accrued expenses Unearned revenue Dividends payable Short-term notes payable Total current liabilities Long-term debt Other noncurrent liabilities Total liabilities Stockholders’ Equity: Common stock Additional paid-in capital Retained earnings Total stockholders’ equity Total liabilities and stockholders’ equity

2-38

$ 21,818 9,223 17,460 2,111 23,883 74,495 134,362 31,605 12,522 $252,984

$30,196 18,453 8,491 11,126 7,718 75,984 47,253 27,857 151,094 2 24,780 77,108 101,890 $252,984

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P2–5. (continued) Req. 4 Current Ratio

=

Current Assets Current Liabilities

=

$74,495 $75,984

= 0.980

For every $1 of short-term liabilities, Apple Inc. has $0.98 of current assets. This suggests that Apple almost has sufficient current resources to pay current liabilities.

This may appear to suggest a liquidity problem. What is more likely, however, is that Apple has a very efficient cash management system and keeps its current resources at lower levels to maximize investment opportunities.

P2–6.

Activity (a) (b) (c) (d) (e) (f)

Borrowed from banks Purchased investments Purchased property, plant, and equipment Issued additional stock Sold short-term investments Declared dividends (does not affect cash flows)

Type of Activity F I I F I NE

Effect on Cash + 18,266  21,000  9,571 + 1,469 + 18,810 NE

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2-39

ALTERNATE PROBLEMS AP2–1.

2-40

Balance Sheet Classification

Debit or Credit Balance

(1)

Prepaid Expenses

CA

Debit

(2)

Inventories

CA

Debit

(3)

Accounts Receivable

CA

Debit

(4)

Long-Term Debt

NCL

Credit

(5)

Cash and Equivalents

CA

Debit

(6)

Goodwill (an intangible asset)

NCA

Debit

(7)

Accounts Payable

CL

Credit

(8)

Income Taxes Payable

CL

Credit

(9)

Property, Plant, and Equipment

NCA

Debit

(10)

Retained Earnings

SE

Credit

(11)

Additional Paid-in Capital

SE

Credit

(12)

Short-Term Borrowings

CL

Credit

(13)

Accrued Liabilities

CL

Credit

(14)

Common Stock

SE

Credit

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AP2–2.

Req. 1 Adamson Incorporated was organized as a corporation. Only a corporation issues shares of capital stock to its owners in exchange for their investment, as Adamson did in transaction (c).

Req. 2 (On next page)

Req. 3 Since the transaction in (i) occurs between the owners and others outside the company, there is no effect on the business due to the separate-entity assumption.

Req. 4 (a)

Total assets = $35,000 + $2,000 + $85,000 + $107,000 + $510,000 = $739,000

(b)

Total liabilities = $169,000 + $170,000 = $339,000

(c)

Total stockholders’ equity = Total assets – Total liabilities = $739,000 – $339,000 = $400,000

(d)

Cash balance = $120,000 + $110,000 – $3,000 + $100,000 – $5,000 – $2,000 – $200,000 – $85,000 = $35,000

(e)

Total current assets = $35,000 + $2,000 = $37,000

Req. 5

Current Ratio

=

Current Assets Current Liabilities

=

$35,000 + $2,000 $169,000

=

$37,000 = 0.22 $169,000

This suggests that Adamson may not have sufficient liquidity to cover its current obligations. Adamson should consider increasing its current assets or seeking to convert some of its short-term debt to long-term debt.

Financial Accounting, 9/e © 2017 by McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

2-41

AP2–2. (continued) Req. 2 Assets

Cash Beg.

=

70,000

310,000

(a) +110,000 (b)

+30,000

=

(c) +100,000 (d)

–5,000

(e)

–2,000

+10,000

=

+2,000 +85,000

Additional Paid-in Retained Common Capital Earnings Stock 20,000 200,000 80,000

+110,000 +27,000 +10,000

+90,000

+30,000

+290,000

+5,000

= =

–3,000

(h) (i) No effect

=

–3,000

= +2,000

+85,000

$739,000

2-42

60,000

Stockholders' Equity

= +200,000

–85,000

+35,000

140,000

=

(f) –200,000 (g)

= =

–3,000

+

Short-Term Long-Term Notes Notes Payable Payable

Notes Long-Term Receivable Investments Equipment Building

120,000

Liabilities

+107,000 +510,000

=

+169,000

+170,000

$339,000

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$400,000

+80,000

AP2–3.

Req. 1 and 2 Cash and Cash Equivalents Beg. 78,519 (a) 1,020 3,400 (b) (d) 4,020 2,980 (e) (g) 310 1,830 (f)

Beg. (e)

Short-Term Investments 12,909 2,980 15,889

15,036 Inventories Beg. 141,692 141,692

75,659 Prepaid Expenses and Other Current Assets Beg. 20,372 20,372

Beg.

Beg.

Accounts Receivable 15,036

Property, Plant, and Equipment Beg. 294,853 (f) 11,230 4,020 (d) 302,063

Other Assets 19,816

Accounts Payable 26,958 Beg.

Beg. (b)

Intangibles 45,128 3,400 48,528

Accrued Expenses Payable 127,639 Beg.

310 (g) 19,506

.

26,958

127,639

Dividends Payable 0 Beg 300 (h) 300

Long-Term Debt* 165,032 Beg. 9,400 (f) 174,432

Other Long-Term Liabilities 27,009 Beg.

Additional Paid-in Capital 359,728 Beg. 1,004 (a) 360,732

Retained Earnings 501,908 Beg. 300 501,608

Common Stock 484 Beg. 16 (a) 500

27,009

(h)

Other Stockholders’ Equity Items Beg. 580,433 580,433

* Current portion is $19.

Financial Accounting, 9/e © 2017 by McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

2-43

AP2–3. (continued) Req. 3 No effect was recorded for (c). Ordering goods involves no exchange or receipt of cash, goods, or services and thus is not a transaction.

Req. 4

Ethan Allen Interiors, Inc. Trial Balance At September 30 (in thousands of dollars)

Cash and cash equivalents Short-term investments Accounts receivable Inventories Prepaid expenses and other current assets Property, plant, and equipment Intangibles Other assets Accounts payable Accrued expenses payable Dividends payable Long-term debt (current portion, $19) Other long-term liabilities Common stock Additional paid-in capital Retained earnings Other stockholders’ equity items Totals

2-44

Debit $ 75,659 15,889 15,036 141,692 20,372 302,063 48,528 19,506

Credit

$

580,433 $1,219,178

26,958 127,639 300 174,432 27,009 500 360,732 501,608

$1,219,178

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AP2–3. (continued) Req. 5 Ethan Allen Interiors, Inc. Balance Sheet At September 30 (in thousands of dollars) Assets Current assets Cash and cash equivalents Short-term investments Accounts receivable Inventories Prepaid expenses and other current assets Total current assets Property, plant, and equipment Intangibles Other assets Total Assets Liabilities Current liabilities Accounts payable Accrued expenses payable Dividends payable Current portion of long-term debt Total current liabilities Long-term debt Other long-term liabilities Total Liabilities Stockholders’ Equity Common stock ($0.01 par value) Additional paid-in capital Retained earnings Other stockholders’ equity items Total Stockholders’ Equity Total Liabilities and Stockholders’ Equity

$ 75,659 15,889 15,036 141,692 20,372 268,648 302,063 48,528 19,506 $638,745

$ 26,958 127,639 300 19 154,916 174,413 27,009 356,338 500 360,732 501,608 (580,433) 282,407 $638,745

Req. 6 Current Ratio

=

Total Current Assets = $268,648 = 1.73 Total Current Liabilities $154,916

Ethan Allen maintains a relatively high current ratio, indicating that they are highly liquid.

Initially, this seems to suggest that they are not investing their resources efficiently.

However, a closer look reveals that a significant portion of their current assets are invested in inventory, which often necessitates a higher current ratio.

Financial Accounting, 9/e © 2017 by McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

2-45

AP2–4.

2-46

Transaction

Type of Activity

Effect on Cash

(a) (b)

F I

+1,020

(c) (d) (e)

NE I I

(f)

I

(g) (h)

I NE

3,400 NE +4,020 2,980 1,830 +310 NE

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CONTINUING PROBLEM CON2–1.

Req. 1

a.

b.

c.

Cash (+A) ………………………………………………….

Equipment (+A) ………………………………………….

Common stock (+SE)…………………….

Additional paid-in capital (+SE)…………

Debit 25,000 36,000

200 60,800

Land (+A)…………………………………………

Building (+A)……………………………………..

Cash (A)………………………………….

Mortgage notes payable (+L)……………

18,000 72,000

Equipment (+A)………………………………….

Cash (A)…………………………………

Short-term notes payable (+L)………….

6,500

10,000 80,000

2,500 4,000

d.

No transaction

e.

Mortgage notes payable (L)…………………..

Cash (A)…………………………………

1,000

Short-term investments (+A)……………………

Cash (A)………………………………….

5,000

f.

g.

Credit

1,000

5,000

No transaction

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2-47

CON2–1. (continued) Req. 2

Beg. (a)

Beg. (b)

Cash 0 25,000 10,000 (b) 2,500 (c) 1,000 (e) 5,000 (f) 6,500

Land 0 18,000 18,000

Short-term Investments Beg. 0 (f) 5,000 5,000

Beg. (b)

Equipment 0 36,000 6,500 42,500

Buildings 0 72,000 72,000

Short-term Notes Payable 0 Beg. 4,000 (c) 4,000

Mortgage Notes Payable 0 Beg. (e) 1,000 80,000 (b) 79,000

Common Stock 0 Beg. 200 (a) 200

Additional Paid-in Capital 0 Beg. 60,800 (a) 60,800

2-48

Beg. (a) (c)

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CON2–1. (continued) Req. 3 Penny’s Pool Service and Supply, Inc. Trial Balance March 31

Cash Short-term investments Equipment Land Buildings Short-term notes payable Mortgage notes payable Common stock Additional paid-in capital Totals

Debit $ 6,500 5,000 42,500 18,000 72,000

Credit

$

$144,000

4,000 79,000 200 60,800

$144,000

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CON2–1. (continued) Req. 4 Penny’s Pool Service and Supply, Inc. Balance Sheet On March 31 Assets Current Assets: Cash Short-term investments Total current assets Equipment Land Buildings Total assets

$

6,500 5,000 11,500 42,500 18,000 72,000 $144,000

Liabilities and Stockholder’s Equity Current Liabilities: Short-term notes payable Total current liabilities Mortgage notes payable Total liabilities Stockholder’s Equity: Common stock ($0.05 par value) Additional paid-in capital Total stockholder’s equity Total liabilities and stockholder’s equity

$4,000 4,000 79,000 83,000 200 60,800 61,000 $144,000

Req. 5

2-50

(a)

Type of Activity (I, F, or NE) F

Effect on Cash Flows (+ or - and amount) + 25,000

(b)

I

- 10,000

(c)

I

- 2,500

(d)

NE

(e)

F

- 1,000

(f)

I

- 5,000

(g)

NE

NE

NE

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CON2–1. (continued) Req. 6

On March 31

Current Assets $11,500

÷ ÷

Current Liabilities $4,000

= =

Current Ratio 2.875

With a current ratio of 2.875, PPSS has liquidity with sufficient current assets to settle short-term obligations. However, this may change as the inventory is received in April and operations begin requiring paying cash for inventory purchases from suppliers, advertising, utilities, employee salary, and other operating needs, and paying notes payable when due. One of the most significant problems for new small businesses is generating sufficient cash from operations to pay obligations and maintain liquidity.

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2-51

CASES AND PROJECTS ANNUAL REPORT CASES

CP2–1.

1. The company is a corporation since it maintains share capital and its owners are referred to as ―stockholders.‖ (Refer to the stockholders’ equity section of the balance sheet).

2. The amount listed on the balance sheet for inventories does not represent the expected selling price. It represents the historical cost of acquiring the inventory, as required by the cost principle.

3. The company’s current obligations include: accounts payable, accrued compensation and payroll taxes, accrued rent, accrued income and other taxes, unredeemed gift cards and gift certificates, current portion of deferred lease credits, and other liabilities and accrued expenses.

4 Current Ratio

=

Current Assets Current Liabilities

=

$890,513 $459,093

= 1.94

The current ratio measures the ability of the company to settle short-term obligations with current assets. American Eagle Outfitters’ current ratio of 1.94 suggests strong liquidity with $1.94 in current assets for every $1 in current liabilities. In the most recent year presented, the company had a significant amount of cash, partly from selling short-term investments.

5. The company spent $245,002,000 on purchasing property and equipment in the year ended 1/31/15; $278,499,000 in the year ended 2/1/14; and $93,939,000 in the year ended 2/2/13. This information is listed as Capital Expenditures on the Statement of Cash Flows in the investing activities section.

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CP2–2.

1.

Assets $1,888,741,000

= =

Liabilities $560,772,000

+ +

Shareholders’ Equity $1,327,969,000

2. No – shareholders’ equity is a residual balance, meaning that the shareholders will receive what remains in cash and assets after the creditors have been satisfied. It is likely that shareholders would receive less than $1,327,969,000. In addition, nearly all assets on the balance sheet are stated at historical cost, not at market value (the amount that could be received if the assets are sold at the end of the year).

3. The company’s only noncurrent liability is Deferred Rent and Other Liabilities.

4. Current Ratio

=

Current Assets Current Liabilities

= $809,117,000 = 2.29 $353,740,000

5. The company had a net cash inflow from investing activities of $194,834,000, primarily because the company sold investments (sold marketable securities for $830,297,000). The company also purchased property and equipment for $229,804,000 and additional marketable securities for $405,659,000.

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CP2–3.

1.

Current Ratio =

Industry Average 2.03

American Eagle Outfitters 1.94

Urban Outfitters 2.29

American Eagle Outfitters’ current ratio of 1.94 is lower than the industry average, but Urban Outfitters’ current ratio of 2.29 is higher the industry average of 2.03. For the year ended January 31, 2015, Urban Outfitters is more able and American Eagle is less able to meet current obligations compared to the industry average.

Many retailers, such as American Eagle Outfitters, choose to rent space rather than purchase buildings for stores. Acquiring buildings often requires borrowing longterm (mortgages). Thus, the choice of renting or purchasing buildings does not have an effect on the numerator or denominator of the current ratio.

2. As indicated in the financing activities section of each company’s statement of cash flows, during the most recent year, American Eagle Outfitters spent $7,464,000 repurchasing common stock from employees and did not repurchase any common stock from investors. Urban Outfitters spent $611,475,000 repurchasing shares.

3. As indicated in the statement of cash flows, American Eagle Outfitters paid $97,224,000 in dividends. Urban Outfitters did not pay any dividends during the year. Refer to the financing activities section of the statement of cash flows.

4. American Eagle reports ―Property and equipment, at cost, net of accumulated depreciation‖ and Urban Outfitters reports ―Property and equipment, net.‖ Details of the amount of land, building, and equipment are reported by each in the notes to the financial statements. Other companies sometimes choose to report these assets separately on the balance sheet, for example in accounts such as: ―Land,‖ ―Buildings and building improvements,‖ Furniture, fixtures and equipment,‖ and ―Rental property and equipment.‖

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FINANCIAL REPORTING AND ANALYSIS CASES CP2–4.

Dollars are in thousands: 1. (a) Chipotle’s total assets reported for the quarter ended September 30, 2014 are $2,437,053. (b) Current liabilities increased over nine months from $199,228 at December 31, 2013, to $264,986 on June 30, 2014. (c) Current Ratio at 9/30/14

=

Current Assets = $873,870 = 3.298 Current Liabilities $264,986

Chipotle’s current ratio increased from the level of 3.298 at the end of September 2014 up to 3.576 on December 31, 2014 (as discussed in the chapter). This indicates that, between September 30, 2014, and December 31, 2014, Chipotle increased its liquidity. Current assets increased by approximately $4 million while current liabilities decreased by about $19 million.

2. (a) For the three months ended September 30, 2014, Chipotle spent $160,400 on the purchase of leasehold improvements, property, and equipment. (b) The total cash flows used in financing activities was $50,503, mostly from the acquisition of the company’s stock from investors ($60,405) called ―treasury stock.‖

CP2–5.

The major deficiency in this balance sheet is the inclusion of the owner’s personal residence as a business asset. Under the separate entity assumption, each business must be accounted for as an individual organization, separate and apart from its owners. The improper inclusion of this asset as part of Frances Sabatier’s business:  Overstates total assets by $300,000; total assets should be $105,000 rather than $405,000, and  Overstates stockholders’ equity that should be only $5,000, rather than $305,000.

Since current assets and current liabilities were not affected, the current ratio remains the same. However, other ratios involving long-term assets and/or stockholders’ equity will be affected.

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CP2–6.

Dollars are in thousands: 1. The company is a corporation because its owners are referred to as ―stockholders.‖ Liabilities + Stockholders’ Equity $1,956,679 + $3,626,403

2.

Assets = $5,583,082 =

3.

Current Assets ÷ Current Liabilities = 2014 $4,255,853 $393,794 2013 2,574,679 225,430

Current Ratio 10.81 11.42

In 2014, for every $1 of current liabilities, Twitter maintains $10.81 of current assets, suggesting that Twitter is highly liquid and has the ability to pay its short-term obligations with current assets in the upcoming year. Since 2013, the current ratio has dropped slightly from 11.42. The interpretation of this ratio would be more useful given information on the company’s current ratio compared to the current ratio for the industry and/or competitors and additional years of data to observe trends.

4. Accounts Payable (L) ........................................................

53,241 Cash (A) ...................................................................... 53,241 5. Over its years in business, it appears that Twitter has been unprofitable, based on a negative amount in Accumulated Deficit of $1,582,470. The Accumulated Deficit account represents the cumulative losses of the firm since the business began.

In addition, Twitter appears unprofitable in the most recent year because Accumulated Deficit increased (due to larger losses). It is possible to determine the amount of net loss by using the following equation, assuming no dividends were declared: (in thousands) Beginning For the Year Ending Accum.. Deficit + Net Income(Loss) – Dividends declared = Accum. Deficit $(994,949) + ?

– $ 0 = $(1,582,470) Thus, net loss for the most recent year was $(587,521).

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CRITICAL THINKING CASES CP2–7.

Req. 1 Dewey, Cheetum, and Howe, Inc. Balance Sheet December 31 Assets Current Assets: Cash Accounts receivable Inventory Total current assets Furniture and fixtures Delivery truck (net) Buildings (net) Total assets

$

1,000 8,000 8,000 17,000 52,000 12,000 60,000 $141,000

Liabilities Current Liabilities: Accounts payable Payroll taxes payable Total current liabilities Notes payable (due in three years) Mortgage payable Total liabilities

$ 16,000 13,000 29,000 15,000 50,000 94,000

Stockholders' Equity Common stock Additional paid-in capital Accumulated deficit Total stockholders' equity Total liabilities and stockholders' equity

4,000 76,000 (33,000) 47,000 $141,000

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2-57

CP2–7. (continued) Req. 2 Dear ___________, I corrected the balance sheet for Dewey, Cheetum, and Howe, Inc. Primarily, I reduced the amount reported for buildings to $60,000 which is the historical cost less any depreciation. Estimated market value is not a generally accepted accounting principle for recording property, plant, and equipment. The $38,000 difference ($98,000 – $60,000) reduces total assets and reduces retained earnings. In fact, retained earnings becomes negative suggesting that there may have been several years of operating losses.

Before making a final decision on investing in this company, you should examine the past three years of audited income statements and the past two years of audited balance sheets to identify positive and negative trends for this company. You can also compare this company's current ratio to that of the industry to assess trends in liquidity, and compare how this company’s long-term debt as a proportion of stockholders’ equity has changed over time. You should also learn as much about the industry as you can by reviewing recent articles on economic and technological trends which may have an impact on this company.

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CP2–8.

1. The most obvious parties harmed by the fraud at Ahold’s U.S. Foodservice, Inc., were the stockholders and creditors. Stockholders were purchasing shares of stock that were inflated due to the fraud. Creditors were lending funds to the company based on inflated income statement and balance sheet information. When the fraud was discovered, the stock price dropped causing the stockholders to lose money on their investments. In addition, the creditors have a lower probability of receiving full payment on their loans. The vendors who assisted in verifying false promotional allowances were also investigated.

Those who were helped by the fraud included the former executives who were able to receive substantial bonuses based on the inflated results of operations. The SEC also charged two individuals with insider trading for trading on a tip illegally.

2. U.S. Foodservice set certain financial goals and tied the former executives’ bonuses to meeting the goals. Adopting targets is a good tool for monitoring progress toward goals and identifying problem areas, such as rising costs or sagging sales. Better decision making can result by heading off potential problems before they grow too large. However, setting unrealistic financial targets, especially in poor economic times, can result in those responsible for meeting the targets circumventing appropriate procedures and policies for their own benefit.

3. In many cases of fraudulent activity, auditors are named in lawsuits along with the company. If the auditors are found to be negligent in performing their audit, then they are liable. However, in many frauds, the management at multiple levels of the organization are so involved in covering the fraud that it becomes nearly impossible for the auditors to detect the fraudulent activity. In this case, it appears that top executives concocted a scheme to induce vendors to confirm false promotional allowance income by signing audit letters agreeing to the false amounts. In audits, confirming balances or amounts with external parties usually provides evidence for the auditors on potential problem areas. The auditors appropriately relied on this external evidence in performing their audit, not knowing it to be tainted or fraudulent.

FINANCIAL REPORTING AND ANALYSIS TEAM PROJECT CP2–9.

The solution to this team project will depend on the companies and/or accounting period selected for analysis.

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Chapter 02 - Investing and Financing Decisions and the Accounting System

CHAPTER 2 INVESTING AND FINANCING DECISIONS AND THE ACCOUNTING SYSTEM Learning Objectives and Related Assignment Materials

Learning Objectives 2-1 Define the objective of financial reporting, the elements of the balance sheet, and the related key accounting assumptions and principles.

2-2 Identify what constitutes a business transaction and recognize common balance sheet account titles used in business.

2-3 Apply transaction analysis to simple business transactions in terms of the accounting model: Assets = Liabilities + Stockholders’ Equity.

2-4 Determine the impact of business transactions on the balance sheet using two basic tools: Journal entries and Taccounts.

2-5 Prepare a trial balance and simple classified balance sheet, and analyze the company using the current ratio.

2-6 Identify investing and financing transactions and demonstrate how they impact cash flows.

MiniExercises Exercises

Problems

Alternate Cases and Continuing Problems Projects Case

1, 2

1

1

1

1, 2, 5, 7

2, 3, 4

1, 2, 3,, 22

1, 2, 3, 5

1, 2, 3

1, 2, 3, 4, 6, 9

2, 5

1, 4, 5

2

2

1, 2, 6, 7, 8, 9

1, 3, 6, 7, 8, 9, 10, 11, 12, 13, 14 15, 17, 18, 19

1, 3, 5

1, 3

6

1

10, 11, 12

9, 10, 11, 12, 15, 16, 17, 20, 22

2, 3, 5

2, 3

1, 2, 3, 4, 5, 6, 7, 9

1

13

20, 21, 22

4, 6

4

1, 2, 3, 4, 9

1

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Chapter 02 - Investing and Financing Decisions and the Accounting System

Synopsis of Chapter Revisions Focus Company: Chipotle Mexican Grill  Chapter 2 introduces the accounting cycle for Chipotle Mexican Grill, a trendy, yet relatively simple company. The chapter integrates financial information for investing and financing activities for the first quarter of 2015, resulting in the company’s actual quarterly balance sheet (with a few simplifications). This fast-casual restaurant does not utilize franchising, thus reducing the complexities found with most other competitors and allowing focused emphasis on transaction analysis, journal entries, T-accounts, and the structure of the balance sheet.  Focus and contrast company data updated.  Update of the conceptual framework to reflect the new definitions from the FASB.  Simplified account titles that relate more closely to end-of-chapter material.  T-accounts now follow each transaction to illustrate posting the effects, while marginal notes have been deleted for a cleaner visual approach.  New additional GUIDED HELP feature provides free access to step-by-step video instruction applying transaction analysis to identify accounts and effects on the accounting equation. This is in addition to the existing Guided Help for recording, posting, and classifying accounts for financing and investing activities.  New CONTINUING PROBLEM added to the end-of-chapter problems based on the activities of Penny’s Pool Service & Supply and its supplier, Pool Corporation. These companies provide a consistent context for summarizing the key points emphasized in each chapter. In Chapter 2, students prepare journal entries, post to T-accounts, prepare a trial balance and classified balance sheet, identify investing and financing activities affecting cash flows, and compute and interpret the current ratio based on the balance sheet for Penny’s Pool Service & Supply.  New and updated real companies, as well as additional exercises on key concepts, in end-of-chapter exercises, problems, and cases.  New Annual Report Case that can be graded through Connect®.

PowerPoint Slides Learning Objectives 2-1 Define the objective of financial reporting, the elements of the balance sheet, and the related key accounting assumptions and principles.

2-2 Identify what constitutes a business transaction and recognize common balance sheet account titles used in business.

2-3 Apply transaction analysis to simple business transactions in terms of the accounting model: Assets = Liabilities + Stockholders’ Equity.

2-4 Determine the impact of business transactions on the balance sheet using two basic tools: Journal entries and T-accounts.

2-5 Prepare a trial balance and simple classified balance sheet and analyze the company using the current ratio.

2-6 Identify investing and financing transactions and demonstrate how they impact cash flows.

PowerPoint® Slides 2-3 through 2-5 2-6 through 2-11 2-12 through 2-19 2-20 through 2-29 2-30 through 2-35 2-36

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Chapter 02 - Investing and Financing Decisions and the Accounting System

Chapter Take-Aways 2-1 Define the objective of financial reporting, the elements of the balance sheet, and the related key accounting assumptions and principles.

Objective:  The primary objective of financial reporting to external users is to provide financial information about the reporting entity that is useful to existing and potential investors, lenders, and other creditors in making decisions about providing resources to the entity.

Qualitative characteristics of useful financial information:  Relevance (including materiality) allows users to assess past activities and/or predict future activities.  Faithful representation requires information to be complete, neutral, and free from error. o To enhance its qualitative characteristics, information should also be comparable (to other companies and over time), verifiable, timely, and understandable.

Key recognition, measurement, and disclosure concepts: Assumptions—  Separate entity assumption—Transactions of the business are accounted for separately from transactions of the owner.  Going concern assumption—A business is expected to continue to operate into the foreseeable future.  Monetary unit assumption—Financial information is reported in the national monetary unit without adjustment for changes in purchasing power.

Principles—  Mixed-attribute measurement model—Most balance sheet elements are recorded following the historical cost (or cost) principle—financial statement elements should be recorded at the cash equivalent cost on the date of the transaction; however, these values may be adjusted to other amounts, such as market value, depending on certain conditions.

Elements of the balance sheet:  Assets—Probable future economic benefits owned or controlled by the entity as a result of past transactions.  Liabilities—Probable future sacrifices of economic benefits arising from present obligations of a business as a result of past transactions.  Stockholders’ equity—Residual interest of owners in the assets of the entity after settling liabilities; the financing provided by the owners (contributed capital) and by business operations (earned capital).

2-2 Identify what constitutes a business transaction and recognize common balance sheet account titles used in business.  An exchange of cash, goods, or services for cash, goods, services, or promises between a business and one or more external parties to a business (not the exchange of a promise for a promise), or  A measurable internal event, such as adjustments for the use of assets in operations.

An account is a standardized format that organizations use to accumulate the dollar effects of transactions related to each financial statement item. Typical balance sheet account titles include the following:  Assets: Cash, Accounts Receivable, Inventory, Prepaid Expenses, Investments, Property (buildings and land) and Equipment, and Intangible (rights without physical substance).  Liabilities: Accounts Payable, Notes Payable, Accrued Expenses Payable, Unearned Revenues, and Taxes Payable.  Stockholders’ Equity: Common Stock, Additional Paid-in Capital, and Retained Earnings.

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Chapter 02 - Investing and Financing Decisions and the Accounting System

Chapter Take-Aways, continued 2-3 Apply transaction analysis to simple business transactions in terms of the accounting model: Assets = Liabilities + Stockholders’ Equity.

To determine the economic effect of a transaction on an entity in terms of the accounting equation, each transaction must be analyzed to determine the accounts (at least two) that are affected. In an exchange, the company receives something and gives up something. If the accounts, direction of the effects, and amounts are correctly analyzed, the accounting equation will stay in balance. The transaction analysis model is:

STOCKHOLDERS’ EQUITY ASSETS (many accounts)

+

–

debit

credit

LIABILITIES =

(many accounts) – + debit credit

Contributed Capital + (2 accounts)

Earned Capital (1 account)

Common Stock and Additional Paid-in Capital – +

Retained Earnings – +

debit

credit Investments by owners

debit Dividends declared

credit Net income (expanded in Ch. 3)

Systematic transaction analysis includes (1) determining the accounts that were received and were given in the exchange, including the type of each account (A, L, or SE), the amounts, and the direction of the effects, and (2) determining that the accounting equation remains in balance.

2-4 Determine the impact of business transactions on the balance sheet using two basic tools: Journal entries and T-accounts.  Journal entries express the effects of a transaction on accounts in a debits-equal-credits format.

The accounts and amounts to be debited are listed first. Then the accounts and amounts to be credited are listed below the debits and indented, resulting in debit amounts on the left and credit amounts on the right. Each entry needs a reference (date, number, or letter).

(a)

Debit 62,300

Cash (+A) Common Stock (+SE) Additional Paid-in Capital (+SE)

Credit 100 62,200

 T-accounts summarize the transaction effects for each account. These tools can be used to determine balances and draw inferences about a company’s activities.

Liabilities and + (dr) Assets (cr)   (dr) Stockholders’ Equity (cr) + Beginning balance Beginning balance Increases Decreases Decreases Increases Ending balance Ending balance

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Chapter 02 - Investing and Financing Decisions and the Accounting System

Chapter Take-Aways, continued 2-5 Prepare a trial balance and simple classified balance sheet, and analyze the company using the current ratio.

A trial balance lists all accounts and their balances, with debit balances in left column and credit balances in the right column. The two columns are added to determine if debits equal credits.

Classified balance sheets are structured as follows:  Assets are categorized as current assets (those to be used or turned into cash within the year, with inventory always considered a current asset) and noncurrent assets, such as long-term investments, property and equipment, and intangible assets.  Liabilities are categorized as current liabilities (those that will be paid with current assets) and long-term liabilities.  Stockholders’ equity accounts are listed as Common Stock (number of shares X par value per share) and Additional Paid-in Capital (number of shares X excess of market value over par value per share) first, followed by Retained Earnings (earnings reinvested in the business).

The current ratio (Current Assets  Current Liabilities) measures a company’s liquidity, that is, the ability of the company to pay its short-term obligations with current assets.

2-6 Identify investing and financing transactions and demonstrate how they impact cash flows.

A statement of cash flows reports the sources and uses of cash for the period by the type of activity that generated the cash flow: operating, investing, and financing. Investing activities include purchasing and selling long-term assets and making loans and receiving principal repayments from others. Financing activities include borrowing from and repaying to banks the principal on loans, issuing and repurchasing stock, and paying dividends.

Key Ratio Current ratio measures the ability of the company to pay its short-term obligations with current assets.

Although a ratio above 1.0 indicates sufficient current assets to meet obligations when they come due, many companies with sophisticated cash management systems have ratios below 1.0. (see the ―Key Ratio Analysis‖ box in the How is the Balance Sheet Prepared and Analyzed? Section): Current Ratio = Current Assets  Current Liabilities

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Chapter 02 - Investing and Financing Decisions and the Accounting System

Finding Financial Information BALANCE SHEET Current Assets Cash Short-term investments Accounts receivable Notes receivable Inventory Prepaid expenses Noncurrent Assets Long-term investments Property and equipment Intangibles

Current Liabilities Accounts payable Accrued expenses payable Short-term notes payable Unearned revenue Noncurrent Liabilities Long-term debt (notes payable) Stockholders’ Equity Common Stock Additional paid-in capital Retained earnings

STATEMENT OF CASH FLOWS Operating Activities To be presented in Chapter 3 Investing Activities + Sales of noncurrent assets and investments for cash  Purchases of noncurrent assets and investments for cash  Loans to others + Receipt of loan principal payments from others Financing Activities + Borrowing from banks  Repayment of loan principal to banks + Issuance of stock  Repurchasing stock  Dividends paid

INCOME STATEMENT To be presented in Chapter 3

NOTES To be discussed in future chapters

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Chapter 02 - Investing and Financing Decisions and the Accounting System

Chapter Outline

Teaching Notes

LO 2-1 Define the objective of financial reporting, the elements of the balance sheet, and the related key accounting assumptions and principles.

I.

Overview of Accounting Concepts––Concepts Emphasized in Chapter 2 A. Objective of Financial Reporting 1. Primary objective of external financial reporting is to provide useful economic information about a business to help external parties make sound financial decisions 2. Decision makers––users of accounting information; include existing and potential investors, lenders, and other creditors.

3. Most are interested in information needed to assess amount, timing, and uncertainty of business’s future cash inflows and outflows.

B. Qualitative Characteristics of Financial Information 1. Relevant information––can influence a decision; it is timely and has predictive and/or feedback value 2. Faithful representation––requires information to be complete, neutral, and free from error 3. Qualitative aspects that enhance the usefulness of information that is relevant and faithfully representative include: comparability, verifiability, timeliness, and understandability C. Recognition and Measurement Concepts 1. Separate-entity assumption––business transactions are accounted for separately from the transactions of owners 2. Going concern assumption (also called continuity assumption)––unless there is evidence to the contrary, business is expected to continue operating into the foreseeable future 3. Monetary unit assumption––each business entity accounts for and reports its financial results primarily in terms of the national monetary unit without any adjustments for changes in purchasing power 4. Mixed-attribute measurement model: a. Applied to measuring different assets and liabilities b. Most balance sheet elements are recorded at their cost (historical cost), which is the cash-equivalent value on the date of the transaction D. Elements of the Balance Sheet 1. Assets––probable future economic benefits owned or controlled by an entity as a result of past transactions or events

Conceptual Framework summarized in Exhibit 2.1

Chipotle’s Balance Sheet illustrated in Exhibit 2.2

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Chapter 02 - Investing and Financing Decisions and the Accounting System

2. Assets are listed in order of liquidity––how soon an asset is expected by management to be turned into cash or used i. Current assets –will be used or turned into cash within one year ii. All other assets are considered long term (or noncurrent); that is, they are to be used or turned into cash after the coming year.

3. Liabilities––probable future sacrifices of economic benefits arising from present obligations of a business to transfer cash or other assets or to provide services as a result of past transactions or events a. Creditors––entities that a company owes money b. Liabilities are usually listed on the balance sheet in order of maturity (how soon an obligation is to be paid) i. Current liabilities––obligations that will be settled by providing cash, goods, other current assets, or services within the coming year ii. All other liabilities are considered long term (or noncurrent) 4. Stockholders’ equity (also called shareholders’ equity or owners’ equity)––the residual interest in the assets of the entity after subtracting liabilities a. Financing provided by owners––referred to as contributed capital b. Financing provided by operations––referred to as earned capital or retained earnings i. When companies earn profits, they can be distributed to owners as dividends or reinvested in the business; the portion of profits reinvested in the business is called retained earnings ii. Companies with a growth strategy often pay little or no dividends to retain funds for expansion

See Financial Analysis feature “Unrecorded But Valuable Assets and Liabilities”

Refer students to Pause for Feedback – Self-Study Quiz

LO 2-2 Identify what constitutes a business transaction and recognize common balance sheet account titles used in business.

II.

What Business Activities Cause Changes in Financial Statement Amounts?

A. Nature of Business Transactions 1. A transaction is: a. An exchange of assets or services for assets, services, or promises to pay between a business and one or more external parties to a business or b. A measurable internal event such as the use of assets in operations 2. Only economic resources and debts resulting from past transactions are recorded on the balance sheet External events––exchanges of assets, goods, or services by one party for assets, services, or promises to pay (liabilities) by one or more other parties

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Chapter 02 - Investing and Financing Decisions and the Accounting System

b. Internal events––include certain events that are not exchanges between the business and other parties but nevertheless have a direct and measurable effect on the entity c. Some important events have a future economic impact on a company, but are not reflected in the financial statements (e.g., an exchange of promises) B. Accounts 1. Account––a standardized format that organizations use to accumulate the dollar effect of transactions on each financial statement item 2. Chart of accounts––a list of all account titles and their unique numbers; are usually organized by financial statement element (asset, liability, stockholders’ equity, revenue, and expense accounts in that order) 3. Every company creates its own chart of accounts to fit the nature of its business activities 4. The accounts in the financial statements of large companies are actually summations of a number of specific accounts in their recordkeeping system

Illustrated in Exhibit 2.3

LO 2-3 Apply transaction analysis to simple business transactions in terms of the accounting model: Assets = Liabilities + Stockholders’ Equity.

III.

How Do Transactions Affect Accounts?

A. Principles of Transaction Analysis 1. Transaction analysis is the process of studying a transaction to determine its economic effect on the entity in terms of the accounting equation 2. Two principles underlying the transaction analysis: a. Every transaction affects at least two accounts; correctly identifying those accounts and the direction of the effect (increase or decrease) is critical b. The accounting equation must remain in balance after each transaction 3. Dual effects concept––every transaction has at least two effects on the basic accounting equation 4. Most transactions with external parties involve an exchange by which the business entity both receives something and gives up something in return a. If Chipotle purchases tomatoes for cash, it receives food supplies (an increase in an asset) and gives up cash (a decrease in an asset) b. If Chipotle purchases tomatoes on credit (that is, money is owed to suppliers) for cash, it would engage in two separate transactions at different points in time i. It receives food supplies (an increase in an asset) and gives a promise to pay later (an increase in a liability) ii. Later, It pays cash (a decrease in an asset) and eliminates the promise (a decrease in a liability)

Stress the importance of a clear understanding of these principles

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Chapter 02 - Investing and Financing Decisions and the Accounting System

c. Not all important business activities result in a transaction that affects the financial statements i. Most importantly, signing a contract involving the exchange of two promises to perform does not result in an accounting transaction that is recorded ii. For example, if Chipotle sent an order for tomatoes to its food supplier and the supplier accepted the order but did not fill it immediately, no transaction took place 5. Balancing the Accounting Equation a. Step 1: Ask––What was received and what was given? i. Identify the account affected by title, making sure that at least two accounts change ii. Classify them by type of account––Asset (A), a liability (L), or a stockholders’ equity (SE) account? iii. Determine the direction of the effect––Did the account increase (+) or decrease (−)? b. Step 2: Verify––Is the accounting equation in balance?

(A = L + SE) B. Analyzing Chipotle’s Transactions 1. Transaction (a) Chipotle issued (sold) 10,000 additional shares of common stock with a par value of $.01 per share and at a market value of $0.37 per share, receiving $3,700 in cash from investors a. Related terminology i. Par value––a legal amount per share established by the board of directors; it represents the minimum amount a stockholder must contribute and has no relationship to the market price of the stock ii. Common stock––the account that is equal to the number of shares issued by a corporation times the par value per share iii. Additional paid-in capital (or Paid-in Capital or Contributed Capital in Excess of Par)––the amount of capital contributed by the shareholders less the par value of the stock a. Step 1: What was received and what was given?

Received: Cash (+A) $3,700 Given: Additional stock shares, Common Stock (+SE) $100 (10,000 shares x $0.01) and Additional Paid-in Capital $3,600 ($3,700 – $100) b. Step 2: Is the accounting equation in balance?

Yes. The left side increased by $3,700 and the right side increased by $3,700 Assets = Liabilities + Stockholders’ Equity Cash (A) + 3,700= Common Stock (SE) + 100 + Additional Paid-in Capital (SE) + 3,600

Use Supplemental Enrichment Activity #1 Use Supplemental Enrichment Activity#2

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Chapter 02 - Investing and Financing Decisions and the Accounting System

2. Transaction (b) Chipotle borrowed $2,000 from its local bank, signing a note to be paid in three years a. Step 1: What was received and what was given?

Received: Cash (+A) $2,000 Given: Written promise to the bank, Long-Term Notes Payable (+L) $2,000 b. Step 2: Is the accounting equation in balance?

Yes. The left side increased by $2,000 and the right side increased by $2,000 Assets = Liabilities + Stockholders’ Equity Cash (A) + 2,000 = Long-Term Notes Payable (L) + 2,000 3. Transaction (c) Chipotle purchased $10,000 in additional land, $8,200 in new buildings, $33,800 in new equipment, and $3,700 in additional intangible assets; paid $53,400 in cash and signing a short-term note payable for the remainder owed ($2,300) a. Step 1: What was received and what was given?

Received: Property and Equipment (+A) $52,000 and Intangible Assets (+A) $3,700 Given: (1) Cash (−A) $53,400 (2) Short-Term Notes Payable (+L) $2,300 b. Step 2: Is the accounting equation in balance?

Yes. The left side increased by $2,300 and the right side increased by $2,300 Assets = Liabilities + Stockholders’ Equity Cash (A) − 53,400 + Property and Equipment (A) + 52,000 + Intangible Assets (A) +3,700 = Short-Term Notes Payable (L) + 2,300 4. Transaction (d) Chipotle paid $2,300 on the short-term note payable in (c) and $2,300 on other noncurrent liabilities (b) (ignore interest) a. Step 1: What was received and what was given?

Received: Reduction in amount due: Short-Term Notes Payable (−L) $2,300 and Other Liabilities (−L) $2,300 Given: Cash (−A) $4,600 b. Step 2: Is the accounting equation in balance?

Yes. The equation stays in balance because assets increase and decrease by the same amount, $4,600 Assets = Liabilities + Stockholders’ Equity Cash (A) – 4,600 = Short-Term Notes Payable (L) − 2,300 + Other Liabilities (L) − 2,300

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Chapter 02 - Investing and Financing Decisions and the Accounting System

5. Transaction (e) Chipotle purchased the stock of other companies as investments, paying $44,000 in cash; of this $9,000 was in short-term investments and $35,000 was in long-term investments a. Step 1: What was received and what was given?

Received: Short-Term Investments (+A) $9,000 and Long-Term Investments (+A) $35,000 Given: Cash (−A) $44,000 b. Step 2: Is the accounting equation in balance?

Yes. The equation stays in balance because assets increase and decrease by the same amount, $44,000 Assets = Liabilities + Stockholders’ Equity Cash (A) – 44,000 + Short-Term Investments (A) + 9,000 + Long-Term Investments (A) + 35,000 = No change 6. Transaction (f) Chipotle’s board of directors declared that the Company will pay $3,000 in cash dividends to shareholders next quarter a. Step 1: What was received and what was given?

Received: Lower claim from stockholders, Retained Earnings (−SE) $3,000 Given: Dividends Payable (+L) $3,000 b. Step 2: Is the accounting equation in balance?

Yes. The equation stays in balance because liabilities increase and stockholders’ equity decreases by the same amount, $3,000 Assets = Liabilities + Stockholders’ Equity No change = Dividends Payable (L) + $3,000 + Retained Earnings (SE) − $3,000

Refer students to Pause for Feedback – Self-Study Quiz

Note that Chipotle does actually not pay dividends; it reinvests profits

Refer students to Pause for Feedback – Self-Study Quiz

LO2-4 Determine the impact of business transactions on the balance sheet using two basic tools: Journal entries and T-accounts.

IV.

How Do Companies Keep Track of Account Balances?

A. The accounting cycle––the process followed by entities to analyze and record transactions, adjust the records at the end of the period, prepare financial statements, and prepare the records for the next cycle; during the accounting cycle: 1. Transactions are analyzed and recorded in the general journal in chronological order 2. The related accounts are updated in the general ledger B. The Direction of Transaction Effects 1. Each account is set up as a ―T‖ with the following structure: a. Increases in asset accounts are on the left because assets are on the left side of the accounting equation b. Increases in liability and stockholders’ equity accounts are on the right because liability and stockholders’ equity are on the right side of the accounting equation

Accounting cycle illustrated in Exhibit 2.4

Illustrated in Exhibit 2.5

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Chapter 02 - Investing and Financing Decisions and the Accounting System

2. Names for each side of an account: a. Debit (dr) is on the left side of the T b. Credit (cr) is on the right side of the T 3. Rules for increases and decreases: a. Asset accounts increase on the left (debit) side and they normally have debit balances b. Liability and stockholders’ equity accounts increase on the right (credit) side and they normally have credit balances 4. Summary: Assets Increase with debits Accounts have debit balances

=

Liabilities Increase with credits Accounts have credit balances

+

Stockholders’ Equity Increase with credits Accounts have credit balances

5. If the correct accounts and effects are identified, the accounting equation will remain in balance because the total debits will equal the total credits in a transaction C. Analytical Tools: 1. Transactions are recorded in chronological order in a general journal (or simply, journal) 2. Journal entry––an accounting method for expressing the effects of a transaction on accounts in a debits-equalcredits format a. It is useful to include a date or some form of reference for each transaction b. The debited accounts are written first (on top) with the amounts recorded in the left column c. The credited accounts are written below the debits and are usually indented with the credited amounts written in the right column d. Compound entry––a journal entry that affects more than two accounts 3. T-account––A tool for summarizing transaction effects for each account, determining balances, and drawing inferences about a company’s activities a. By themselves, journal entries do not provide the balances in accounts b. After journal entries are recorded, the dollar amounts are posted (transferred) to each account affected by the transaction to determine the new account balances c. As a group, the accounts are called a general ledger

Refer students to Pause for Feedback – Self-Study Quiz

Posting transaction effects illustrated in Exhibit 2.6 See Financial Analysis feature “Inferring Business Activities from T-Accounts” T-accounts illustrated in Exhibit 2.7

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Chapter 02 - Investing and Financing Decisions and the Accounting System

D. Transaction Analysis Illustrated 1. Transaction (a) Chipotle issued (sold) 10,000 additional shares of common stock with a par value of $.01 per share and at a market value of $0.37 per share, receiving $3,700 in cash from investors dr Cash (+A) 3,700 cr Common Stock (+SE) 100 cr Additional Paid-in Capital (SE) 3,600 Assets = Liabilities + Stockholders’ Equity Cash (A) + 3,700 = Common Stock (SE) + 100 + Additional Paid-in Capital + 3,600 (SE) 2. Transaction (b) Chipotle borrowed $2,000 from its local bank, signing a note to be paid in three years dr Cash (+A) 2,000 cr Long-Term Notes Payable (+L) 2,000 Assets = Liabilities + Stockholders’ Equity Cash (A) + 2,000 = Long-Term Notes Payable (L) + 2,000 3. Transaction (c) Chipotle purchased $10,000 in additional land, $8,200 in new buildings, $33,800 in new equipment, and $3,700 in additional intangible assets; paid $53,400 in cash and signing a short-term note payable for the remainder owed ($2,300) dr Land (+A) 10,000 dr Buildings (+A) 8,200 dr Equipment (+A) 33,800 dr Intangible Assets (+A) 3,700 cr Cash (–A) 53,400 cr Short-Term Notes Payable (+L) 2,300 Assets = Liabilities + Stockholders’ Equity Cash (A) – 53,400 + Land (A) + 10,000 + Buildings (A) + 8,200 + Equipment (A) + 33,800 + Intangible Assets (A) + 3,700 = Short-Term Notes Payable (L) + 2,300 4. Transaction (d) Chipotle paid $2,300 on the short-term note payable in (c) and $2,300 on other noncurrent liabilities (b) (ignore interest) dr Short-Term Notes Payable (–L) 2,300 dr Other Liabilities (–L) 2,300 cr Cash (–A) 4,600 Assets = Liabilities + Stockholders’ Equity Cash (A) − $4,600 = Short -Term Notes Payable (L) − $2,300 + Other Liabilities (L) – 2,300

Use Supplemental Enrichment Activity #3 Use Supplemental Enrichment Activity#4

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Chapter 02 - Investing and Financing Decisions and the Accounting System

5. Transaction (e) Chipotle purchased the stock of other companies as investments, paying $44,000 in cash; of this $9,000 was in short-term investments and $35,000 was in long-term investments dr Short-Term Investments (+A) 35,000 dr Long-Term Investments (+A) 9,000 cr Cash (–A) 44,000 Assets = Liabilities + Stockholders’ Equity Cash (A) – 44,000 + Short-Term Investments (A) + 35,000 + Long-Term Investments (A) + 9,000 = No change 6. Transaction (a) Chipotle’s board of directors declared that the Company will pay $3,000 in cash dividends to shareholders next quarter dr Retained Earnings (–SE) 3,000 cr Dividends Payable (+L) 3,000 Assets = Liabilities + Stockholders’ Equity No change = Dividends Payable (L) + $3,000 + Retained Earnings (SE) − $3,000 7. Posting of these transactions to the T-accounts is illustrated in the text after the analysis of transaction (f)

Refer students to Pause for Feedback – Self-Study Quiz Use Supplemental Enrichment Activity #5

LO 2-5 Prepare a trial balance and simple classified balance sheet and analyze the company using the current ratio.

V.

How Is the Balance Sheet Prepared and Analyzed?

A. Trial Balance 1. Trial balance––list of all accounts with their balances to provide a check on the equality of the debits and credits 2. A trial balance spreadsheet is created first for internal purposes before preparing statements for external users 3. A trial balance lists the names of the T-accounts in one column in financial statement order (assets, liabilities, stockholders’ equity, revenues, and expenses), with their ending debit or credit balances in the next two columns 4. Debit balances are indicated in the left column and credit balances are indicated in the right column 5. Then the two columns are totaled to provide a check on the equality of the debits and credits 6. Errors in a computer-generated trial balance may exist if wrong accounts and/or amounts are used in the journal entries B. Classified Balance Sheet 1. Prepared from the trial balance 2. The assets and liabilities are classified into two categories: current and noncurrent 3. Dollar signs are indicated at the top and bottom of the asset section and top and bottom of the liabilities and shareholders’ equity section

Use Supplemental Enrichment Activity #7

Chipotle’s Balance Sheet illustrated in Exhibit 2.8 Use Supplemental Enrichment Activity #7

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Chapter 02 - Investing and Financing Decisions and the Accounting System

4. Includes comparative data; when multiple periods are presented, the most recent balance sheet amounts are usually listed on the left C. Ratio Analysis in Decision Making 1. Users of financial information compute a number of ratios in analyzing a company's past performance and financial condition as input in predicting its future potential 2. How ratios change over time and how they compare to the ratios of the company's competitors or industry averages provide valuable information about a company's strategies for its operating, investing, and financing activities..

D. Key Ratio Analysis: Current Ratio 1. Current Ratio = Current Assets – Current Liabilities 2. Creditors and security analysts use the current ratio to measure the ability of the company to pay its short-term obligations with short-term assets 3. Generally, the higher the ratio, the more cushion a company has to pay its current obligations if future economic conditions take a downturn 4. While a high ratio normally suggests good liquidity, too high of a ratio suggests inefficient use of resources 5. An old rule of thumb was that companies should have a current ratio between 1.0 and 2.0; today, many strong companies have current ratios below 1.0

See Financial Analysis feature “Understanding Foreign Financial Statements”

Use Supplemental Enrichment Activity #8

Refer students to Pause for Feedback – Self-Study Quiz

LO 2-6 Identify investing and financing transactions and demonstrate how they impact cash flows.

VI.

Focus on Cash Flows - Investing and Financing Activities A. The statement of cash flows divides all transactions that affect cash into three categories: 1. Operating activities (covered in Chapter 3) 2. Investing activities include buying and selling noncurrent assets and investments 3. Financing activities include borrowing and repaying debt, including short-term bank loans, issuing and repurchasing stock, and paying dividends

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Chapter 02 - Investing and Financing Decisions and the Accounting System

4. Effects of transactions in this chapter on the statement of cash flows: Operating Activities (None of the transactions impact operating activities) Investing Activities Purchasing long-term assets and investments for  cash + Selling long-term assets and investments for cash  Lending cash to others + Receiving principal payments on loans made to others Financing Activities + Borrowing cash from banks  Repaying the principal on borrowings from banks + Issuing stock for cash  Repurchasing stock with cash  Paying cash dividends

Refer students to Pause for Feedback – Self-Study Quiz



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Chapter 02 - Investing and Financing Decisions and the Accounting System

Supplemental Enrichment Activities Note: These activities would be suitable for individual or group activities.

1. Handout 2-1 Use this handout for an in-class activity designed to review the analysis of various investing and financing transactions. The solution follows the handout master.

2. Handout 2-2 This activity is a continuation of Activity #1. Use this handout for an in-class activity designed to continue the review of the analysis of various investing and financing transactions. The solution follows the handout master.

3. Handout 2-3 Use Handout 2-3 for an in-class activity designed to review the debit/credit framework. Note that these transactions are the same as those analyzed on Handout 2-1. However, it can be assigned even if Activity #1 was not assigned. The solution follows the handout master.

4. Handout 2-4 This activity is a continuation of Activity #3. Use this handout for an in-class activity designed to review the debit/credit framework. Note that these transactions are the same as those analyzed on Handout 2-2. However, it can be assigned even if Activity #2 was not assigned. The solution follows the handout master.

5. Handout 2-5 Use this handout for an in-class activity designed to review the posting of various investing and financing transactions to T-accounts. This activity is a continuation of Activity #3 and Activity #4; it should be assigned only if both of those activities were assigned. The solution follows the handout master.

6. Handout 2-6 Use this handout for an in-class activity designed to review the preparation of a trial balance. This activity is a continuation of Activity #5; it should be assigned only if that activity was assigned. The solution follows the handout master.

7. Handout 2-7 Use this handout for an in-class activity designed to review the preparation of a classified balance sheet. This activity is a continuation of Activity #6; it should be assigned only if that activity was assigned. The solution follows the handout master.

8. Use Handout 2-8 Use this handout for an in-class activity designed to review the calculation and interpretation of the current ratio. This activity is a continuation of Activity #7; it should be assigned only if that activity was assigned. The solution follows the handout master.

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Chapter 02 - Investing and Financing Decisions and the Accounting System

HANDOUT 2 – 1 ANALYZING TRANSACTIONS Analyze each of the following transactions of World Wide Webster by performing each of the following steps. Then, use the chart on the following page to (1) keep track of the amount in each account and (2) ensure the accounting equation is in balance. (a) Stockholder invests $10,000 into the business in exchange for 10,000 shares of $1 par value common stock.

1. Decide if a transaction took place.

2. Identify the accounts affected.

3. Classify each account affected.

4. Identify direction and amount.

5. Ensure the accounting equation is in balance. (b) Borrow $15,000 signing a note payable to the bank that is due in three months.

1. Decide if a transaction took place.

2. Identify the accounts affected.

3. Classify each account affected.

4. Identify direction and amount.

5. Ensure the accounting equation is in balance. (c) Acquire a $15,000 truck and $5,000 worth of equipment.

1. Decide if a transaction took place.

2. Identify the accounts affected.

3. Classify each account affected.

4. Identify direction and amount.

5. Ensure the accounting equation is in balance.

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Chapter 02 - Investing and Financing Decisions and the Accounting System

HANDOUT 2 – 1, continued (d) Purchase $300 worth of supplies from a vendor on credit. (―On credit,‖ or ―on account,‖ means that the company received the supplies now and will pay for them later.)

1. Decide if a transaction took place.

2. Identify the accounts affected.

3. Classify each account affected.

4. Identify direction and amount.

5. Ensure the accounting equation is in balance. (e) Sign contract for first website design for $10,000.

1. Decide if a transaction took place.

2. Identify the accounts affected.

3. Classify each account affected.

4. Identify direction and amount.

5. Ensure the accounting equation is in balance.

Chart Assets

Ref. (a) (b) (c) (d) Total

=

Cash + Supplies + Equipment =

Liabilities

Accounts Payable

+

ShortTerm Notes Payable

+

Stockholders’ Equity

+

Common Stock

= = = = = = =

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Chapter 02 - Investing and Financing Decisions and the Accounting System

HANDOUT 2 – 1 SOLUTION, continued ANALYZING TRANSACTIONS Analyze each of the following transactions of World Wide Webster by performing each of the following steps. Then, use the chart on the following page to (1) keep track of the amount in each account and (2) ensure the accounting equation is in balance. (a) Stockholder invests $10,000 into the business in exchange for 10,000 shares of $1 par value common stock.

1. Decide if a transaction took place.

Yes – received cash and gave stock.

2. Identify the accounts affected.

Cash and Common Stock

3. Classify each account affected.

Cash is an Asset (A) and Common Stock is Stockholders’ Equity (SE)

4. Identify direction and amount.

Cash (A) + $10,000 = Common Stock (SE) + $10,000.

5.

Ensure the accounting equation is in balance.

Yes – see below.

(b) Borrow $15,000 signing a note payable to the bank that is due in three months.

1. Decide if a transaction took place.

Yes – received cash and gave a short-term note payable.

2. Identify the accounts affected.

Cash and Short-Term Notes Payable

3. Classify each account affected.

4. Identify direction and amount.

5.

Ensure the accounting equation is in balance.

Cash is an Asset (A) and Short-Term Notes Payable is a Liability (L) Cash (A) + $15,000 = Short-Term Notes Payable + $15,000.

Yes – see below.

(c) Acquire a $15,000 truck and $5,000 worth of equipment.

1.

Decide if a transaction took place.

Yes – paid cash and received truck and equipment.

2.

Identify the accounts affected.

Cash and Equipment

3.

Classify each account affected.

Cash is an Asset (A) and Equipment is an Asset (A)

4.

Identify direction and amount.

Cash (A) - $20,000 and Equipment (A) + $20,000

5.

Ensure the accounting equation is in balance.

Yes – see below.

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Chapter 02 - Investing and Financing Decisions and the Accounting System

HANDOUT 2 – 1 SOLUTION, continued (d) Purchase $300 worth of supplies from a vendor on credit. (―On credit,‖ or ―on account,‖ means that the company received the supplies now and will pay for them later.)

1.

Decide if a transaction took place.

Yes – received supplies and obligated to pay for them.

2.

Identify the accounts affected.

Supplies and Accounts Payable

3.

Classify each account affected.

Supplies is an Asset (A) and Accounts Payable is a Liability (L)

4.

Identify direction and amount.

Supplies (A) + $300 and Accounts Payable (L) + $300.

5.

Ensure the accounting equation is in balance.

Yes – see below.

(e) Sign contract for first website design for $10,000.

No – no exchange took place.

1.

Decide if a transaction took place.

2.

Identify the accounts affected.

3.

Classify each account affected.

4.

Identify direction and amount.

5.

Ensure the accounting equation is in balance.

Chart Assets

=

Ref. Cash + Supplies + Equipment (a) +10,000 (b) +15,000 (c) –20,000 +20,000 (d) +300 Total 5,000 300 20,000 Assets $25,300

= = = = =

Liabilities

Accounts Payable +

ShortTerm Notes Payable

+

+

Stockholders’ Equity

Common Stock +10,000

+15,000

+300 300 15,000 10,000 = Liabilities $15,300 + Stockholders’ Equity $10,000 $25,300 = $25,300

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Chapter 02 - Investing and Financing Decisions and the Accounting System

HANDOUT 2 – 2 ANALYZING TRANSACTIONS Analyze each of the following transactions of World Wide Webster by performing each of the following steps. Then, use the chart on the following page to (1) keep track of the amount in each account and (2) ensure the accounting equation is in balance. (f) Company pays $300 on accounts payable to the vendor in (d).

1. Decide if a transaction took place.

2. Identify the accounts affected.

3. Classify each account affected.

4. Identify direction and amount.

5. Ensure the accounting equation is in balance. (g) Company pays for and receives $600 worth of supplies.

1. Decide if a transaction took place.

2. Identify the accounts affected.

3. Classify each account affected.

4. Identify direction and amount.

5. Ensure the accounting equation is in balance. (h) Company acquires and receives $1,000 worth of equipment.

1. Decide if a transaction took place.

2. Identify the accounts affected.

3. Classify each account affected.

4. Identify direction and amount.

5. Ensure the accounting equation is in balance.

2-23 Š 2017 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 02 - Investing and Financing Decisions and the Accounting System

HANDOUT 2 – 2, continued (i) Order a $900 lawn mower, to be delivered next month.

1. Decide if a transaction took place.

2. Identify the accounts affected.

3. Classify each account affected.

4. Identify direction and amount.

5. Ensure the accounting equation is in balance.

Chart Assets

Ref.

Cash

=

+ Supplies + Equipment =

(a)

+10,000

=

(b)

+15,000

=

(c)

–20,000

+20,000 =

(d)

+300

Liabilities

Accounts Payable +

=

(f)

=

(g)

=

(h)

=

(i)

=

Total

=

ShortTerm Notes Payable

+

+

Stockholders’ Equity

Common Stock +10,000

+15,000

+300

= =

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Chapter 02 - Investing and Financing Decisions and the Accounting System

HANDOUT 2 – 2 SOLUTION ANALYZING TRANSACTIONS Analyze each of the following transactions of World Wide Webster by performing each of the following steps. Then, use the chart on the following page to (1) keep track of the amount in each account and (2) ensure the accounting equation is in balance. (f) Company pays $300 on accounts payable to the vendor in (d).

1. Decide if a transaction took place.

Yes – paid cash to reduce accounts payable.

2. Identify the accounts affected.

Cash and Accounts Payable

3. Classify each account affected.

Cash is an Asset (A) and Accounts Payable is a Liability (L)

4. Identify direction and amount.

Cash (A) – $300 = Liabilities (L) – $300

5.

Ensure the accounting equation is in balance.

Yes – see below.

(g) Company pays for and receives $600 worth of supplies.

1. Decide if a transaction took place.

Yes – paid cash to purchase supplies.

2. Identify the accounts affected.

Cash and Supplies

3. Classify each account affected.

Cash is an Asset (A) and Supplies is an Asset

4. Identify direction and amount.

Cash (A) – $600 and Supplies (A) + $600.

5.

Ensure the accounting equation is in balance.

Yes - see below.

(h) Company acquires and receives $1,000 worth of equipment.

1. Decide if a transaction took place.

Yes – paid cash to purchase equipment

2. Identify the accounts affected.

Cash and Equipment

3. Classify each account affected.

Cash is an Asset (A) and Equipment is an Asset (A)

4. Identify direction and amount.

Cash (A) – $1,000 and Equipment (A) + $1,000

5.

Ensure the accounting equation is in balance.

Yes - see below.

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Chapter 02 - Investing and Financing Decisions and the Accounting System

HANDOUT 2 – 2 SOLUTION, continued (i) Order a $900 computer, to be delivered next month.

1. Decide if a transaction took place.

No exchange took place.

2. Identify the accounts affected.

3. Classify each account affected.

4. Identify direction and amount.

5.

Ensure the accounting equation is in balance.

Chart Assets

Ref.

Cash

=

+ Supplies + Equipment =

(a)

+10,000

=

(b)

+15,000

=

(c)

–20,000

+20,000 =

(d)

+300

(f)

–300

(g)

–600

(h)

–1,000

Liabilities

Accounts Payable +

=

+

ShortTerm Notes Payable

+

Stockholders’ Equity

Common Stock +10,000

+15,000

+300 –300

+600 +1,000

(i) Total

3,100

900

21,000

0

15,000

10,000

Assets $25,000 = Liabilities $15,000 + Stockholders’ Equity $10,000 $25,000 = $25,000

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Chapter 02 - Investing and Financing Decisions and the Accounting System

HANDOUT 2 – 3 THE DEBIT/CREDIT FRAMEWORK Analyze each of the following transactions of World Wide Webster and prepare the journal entry required to record the related transaction. (a) Stockholder invests $10,000 into the business in exchange for 10,000 shares of $1 par value common stock.

Debit and credit the accounts affected

Ensure the equation still balances and debits = credits Assets = Liabilities

+

Stockholders’ Equity

(b) Borrow $15,000 signing a note payable to the bank that is due in three months.

Debit and credit the accounts affected

Ensure the equation still balances and debits = credits Assets = Liabilities

+

Stockholders’ Equity

+

Stockholders’ Equity

(c) Acquire a $15,000 truck and $5,000 worth of equipment.

Debit and credit the accounts affected

Ensure the equation still balances and debits = credits Assets = Liabilities

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Chapter 02 - Investing and Financing Decisions and the Accounting System

HANDOUT 2 – 3, continued (d) Purchase $300 worth of supplies from a vendor on credit. (―On credit,‖ or ―on account,‖ means that the company received the supplies now and will pay for them later.)

Debit and credit the accounts affected

Ensure the equation still balances and debits = credits Assets = Liabilities

+

Stockholders’ Equity

+

Stockholders’ Equity

(e) Sign contract for first website design for $10,000.

Debit and credit the accounts affected

Ensure the equation still balances and debits = credits Assets = Liabilities

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Chapter 02 - Investing and Financing Decisions and the Accounting System

HANDOUT 2 – 3 SOLUTION THE DEBIT/CREDIT FRAMEWORK Analyze each of the following transactions of World Wide Webster and prepare the journal entry required to record the related transaction. (a) Stockholder invests $10,000 into the business in exchange for 10,000 shares of $1 par value common stock.

Debit and credit the accounts affected (a) Cash (+A) Common Stock (+SE)

10,000 10,000

Ensure the equation still balances and debits = credits Assets = Liabilities Cash +10,000

+

Stockholders’ Equity Common +10,000 Stock

(b) Borrow $15,000 signing a note payable to the bank that is due in three months.

Debit and credit the accounts affected (b) Cash (+A) Short-Term Notes Payable (+L)

15,000 15,000

Ensure the equation still balances and debits = credits Assets = Liabilities + Cash +15,000 Short-Term +15,000 Notes Payable

Stockholders’ Equity

(c) Acquire a $15,000 truck and $5,000 worth of equipment.

Debit and credit the accounts affected (c) Equipment (+A) Cash (–A)

20,000 20,000

Ensure the equation still balances and debits = credits Assets = Liabilities Cash –20,000 Equipment +20,000

+

Stockholders’ Equity

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Chapter 02 - Investing and Financing Decisions and the Accounting System

HANDOUT 2 – 3 SOLUTION, continued (d) Purchase $300 worth of supplies from a vendor on credit. (―On credit,‖ or ―on account,‖ means that the company received the supplies now and will pay for them later.)

Debit and credit the accounts affected (d) Supplies (+A) Accounts Payable (+A)

300 300

Ensure the equation still balances and debits = credits Assets = Liabilities Supplies +300 Accounts Payable

+

Stockholders’ Equity

+300

(e) Sign contract for first website design for $10,000.

No entry – this is not a transaction

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Chapter 02 - Investing and Financing Decisions and the Accounting System

HANDOUT 2 – 4 THE DEBIT/CREDIT FRAMEWORK Analyze each of the following transactions of World Wide Webster and prepare the journal entry required to record the related transaction. (f) Company pays $300 on accounts payable to the vendor in (d).

Debit and credit the accounts affected

Ensure the equation still balances and debits = credits Assets

=

Liabilities

+

Stockholders’ Equity

+

Stockholders’ Equity

+

Stockholders’ Equity

(g) Company pays for and receives $600 worth of supplies.

Debit and credit the accounts affected

Ensure the equation still balances and debits = credits Assets

=

Liabilities

(h) Company acquires and receives $1,000 worth of equipment.

Debit and credit the accounts affected

Ensure the equation still balances and debits = credits Assets

=

Liabilities

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Chapter 02 - Investing and Financing Decisions and the Accounting System

HANDOUT 2 – 4, continued (i) Order a $900 computer, to be delivered in 90 days.

Debit and credit the accounts affected

Ensure the equation still balances and debits = credits Assets

=

Liabilities

+

Stockholders’ Equity

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Chapter 02 - Investing and Financing Decisions and the Accounting System

HANDOUT 2 – 4 SOLUTION THE DEBIT/CREDIT FRAMEWORK Analyze each of the following transactions of World Wide Webster and prepare the journal entry required to record the related transaction. (f) Company pays $300 on accounts payable to the vendor in (d).

Debit and credit the accounts affected (f)

Accounts Payable (–L) Cash (–A)

300 300

Ensure the equation still balances and debits = credits Assets = Liabilities Cash –300 Acct. Pay.

+

Stockholders’ Equity

–300

(g) Company pays for and receives $600 worth of supplies.

Debit and credit the accounts affected (g)

Supplies (+A) Cash (–A)

600 600

Ensure the equation still balances and debits = credits Assets = Liabilities Supplies +600 Cash

+

Stockholders’ Equity

–600

(h) Company acquires and receives $1,000 worth of equipment.

Debit and credit the accounts affected (h)

Equipment (+A) Cash (–A)

1,000 1,000

Ensure the equation still balances and debits = credits Assets = Liabilities Equipment +1,000 Cash

+

Stockholders’ Equity

–1,000

(i) Order a $900 computer, to be delivered in 90 days.

No entry – this is not a transaction.

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Chapter 02 - Investing and Financing Decisions and the Accounting System

HANDOUT 2 – 5 POSTING TO T-ACCOUNTS Post the transactions from handouts 2-3 and 2-4 and determine the ending balances of each of the following T-accounts.

Assets

Liabilities

Stockholders’ Equity

+ Cash –

- Accounts Payable +

- Common Stock +

+ Supplies –

- Short-Term Notes Payable +

- Retained Earnings +

+ Equipment –

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Chapter 02 - Investing and Financing Decisions and the Accounting System

HANDOUT 2 – 5 SOLUTION POSTING TO T-ACCOUNTS Post the transactions from handouts 2-3 and 2-4 and determine the ending balances of each of the following T-accounts.

Assets + Cash – BegBal 0 (a) 10,000 (b) 15,000 20,000 300 600 1,000 EndBal 3,100

BegBal (d) (g) EndBal

+ Supplies – 0 300 600 900

Liabilities

(c) (f) (g) (h)

- Accounts Payable + 0 BegBal (f) 300 300 (d) 0 EndBal

Stockholders’ Equity - Common Stock + 0 BegBal 10,000 (a) 10,000 EndBal

- Short-Term Notes Payable + 0 BegBal 15,000 (b) 15,000 EndBal

- Retained Earnings + 0 BegBal 0 EndBal

+ Equipment – BegBal 0 (c) 20,000 (h) 1,000 EndBal 21,000

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Chapter 02 - Investing and Financing Decisions and the Accounting System

HANDOUT 2 – 6 PREPARING A TRIAL BALANCE Use the ending balances from the T-accounts on Handout 2-5 to prepare a trial balance for World Wide Webster as of December 31 of the current year.

World Wide Webster Trial Balance At December 31, Current Year Debit

Credit

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Chapter 02 - Investing and Financing Decisions and the Accounting System

HANDOUT 2 – 6 PREPARING A TRIAL BALANCE Use the ending balances from the T-accounts on Handout 2-5 to prepare a trial balance for World Wide Webster as of December 31 of the current year.

World Wide Webster Trial Balance At December 31, Current Year

Cash Supplies Equipment Short-Term Notes Payable Common Stock Totals

Debit $ 3,100 900 21,000

$25,000

Credit

$15,000 10,000 $25,000

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Chapter 02 - Investing and Financing Decisions and the Accounting System

HANDOUT 2 – 7 SOLUTION PREPARING A BALANCE SHEET Use the balances from the trial balance on Handout 2-6 to prepare a classified balance sheet for World Wide Webster as of December 31 of the current year.

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Chapter 02 - Investing and Financing Decisions and the Accounting System

HANDOUT 2 – 7 SOLUTION PREPARING A BALANCE SHEET Use the balances from the trial balance on Handout 2-6 to prepare a classified balance sheet for World Wide Webster as of December 31 of the current year.

World Wide Webster Balance Sheet At December 31, Current Year Assets Current Assets: Cash Supplies Total Current Assets Equipment Total Assets

$ 3,100 900 4,000 21,000 $25,000 Liabilities

Current Liabilities: Short-Term Notes Payable Total Current Liabilities

$15,000 15,000

Stockholders’ Equity Common Stock Retained Earnings Total Stockholders’ Equity Total Liabilities and Stockholders’ Equity

10,000 0 10,000 $25,000

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Chapter 02 - Investing and Financing Decisions and the Accounting System

HANDOUT 2 – 8 CURRENT RATIO Refer to the classified balance sheet from Handout 2-7 and calculate the current ratio of World Wide Webster as of December 31 of the current year. Then, interpret the current ratio.

Calculation:

Interpretation:

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Chapter 02 - Investing and Financing Decisions and the Accounting System

HANDOUT 2 – 8 SOLUTION CURRENT RATIO Refer to the classified balance sheet from Handout 2-7 and calculate the current ratio of World Wide Webster as of December 31 of the current year. Then, interpret the current ratio.

Calculation: Current Ratio = Current Assets ÷ Current Liabilities Current ratio = $4,000 ÷ $15,000 = 0.27 Interpretation: A current ratio of 0.27 indicates that the company has $0.27 of current assets for $1.00 of current liabilities. It does not appear that the company’s current assets are sufficient to pay its current liabilities.

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chapter

2

Investing and Financing Decisions and the Accounting System

Financial Accounting 9e Libby • Libby • Hodge

Copyright ©2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

2-1

Learning Objectives After studying this chapter, you should be able to: 2-1 Define the objective of financial reporting, the elements of the balance sheet, and the related key accounting assumptions and principles.

2-2 Identify what constitutes a business transaction and recognize common balance sheet account titles used in business.

2-3 Apply transaction analysis to simple business transactions in terms of the accounting model: Assets = Liabilities + Stockholders' Equity.

2-4 Determine the impact of business transactions on the balance sheet using two basic tools: Journal entries and T-accounts.

2-5 Prepare a trial balance and simple classified balance sheet, and analyze the company using the current ratio.

2-6 Identify investing and financing transactions and demonstrate how they impact cash flows.

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2-2

Understanding the Business

What business activities cause changes in the balance sheet?

To understand amounts appearing on a company’s balance sheet:

How do specific activities affect each balance?

How do companies keep track of balance sheet amounts?

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2-3

Exhibit 2.1 Financial Accounting and Reporting Conceptual Framework Objective of Financial Reporting to External Users: (Ch. 2) To provide financial information about the reporting entity that is useful to existing and potential investors, lenders, and other creditors in making decisions about providing resources to the entity ďƒ˜ Pervasive Cost-Benefit Constraint: Benefits of providing information should outweigh its costs Fundamental Qualitative Characteristics of Useful Information: (Ch. 2) Relevance (including materiality) and Faithful Representation Attributes That Enhance Qualitative Characteristics: Comparability (including consistency), Verifiability, Timeliness, and Understandability

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2-4

Exhibit 2.1 Financial Accounting and Reporting Conceptual Framework Objective of Financial Reporting to External Users: (Ch. 2) To provide financial information about the reporting entity that is useful to existing and potential investors, lenders, and other creditors in making decisions about providing resources to the entity.  Pervasive Cost-Benefit Constraint: Benefits of providing information should outweigh its costs Fundamental Qualitative Characteristics of Useful Information: (Ch. 2) Relevance (including materiality) and Faithful Representation Attributes That Enhance Qualitative Characteristics: Comparability (including consistency), Verifiability, Timeliness, and Understandability Elements to Be Measured and Reported: Assets, Liabilities, Stockholders’ Equity, Investments by Owners, and Distributions to Owners (Ch. 2) Revenues, Expenses, Gains, and Losses (Ch. 3) Comprehensive Income (Ch. 5) Recognition, Measurement, and Disclosure Concepts: Assumptions: Separate Entity, Going Concern, and Monetary Unit (Ch. 2) Time Period (Ch. 3) Principles: Mixed-Attribute Measurement (Ch. 2) Revenue Recognition and Expense Recognition (Ch. 3) Full Disclosure (Ch. 5)

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2-5

Elements of the Balance Sheet

A = L + SE Assets

Liabilities

Economic resources with probable future benefits owned or controlled by the entity.

Debts or obligations (claims to a company’s resources) that result from a company’s past transactions and will be paid with assets or services.

Entities that a company owes money to are called creditors.

Stockholders’ Equity The financing provided by the owners and business operations.

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2-6

Exhibit 2.2 Chipotle Mexican Grill, Inc., Balance Sheet CHIPOTLE MEXICAN GRILL, INC.

*The information has been adapted from actual statements and simplified for this chapter.

Consolidated Balance Sheet* December 31, 2014 (in thousands of dollars, except per share data)

Current assets

Noncurrent assets

Current liabilities

Noncurrent liabilities Stockholders’ equity

ASSETS Current Assets: Cash Short-term investments Accounts receivable Supplies Prepaid expenses Total current assets Property and equipment: Land Buildings Equipment Total cost Accumulated depreciation Net property and equipment Long-term investments Intangible assets Total assets

$ 419,500 338,600 34,800 15,300 70,300 878,500 11,100 1,267,100 442,500 1,720,700 (613,700) 1,107,000 496,100 64,700 $2,546,300

LIABILITIES AND STOCKHOLDERS’ EQUITY Current Liabilities: Accounts payable $ 69,600 Unearned revenue 16,800 Accrued expenses payable: Wages payable 73,900 Utilities payable 85,400 Total current liabilities 245,700 Other liabilities 288,200 Total liabilities 533,900 Stockholders’ Equity: Common stock ($0.01 par value) 400 Additional paid-in capital 290,200 Retained earnings 1,721,800 Total stockholders’ equity 2,012,400 Total liabilities and stockholders’ equity $2,546,300

EXPLANATIONS “Consolidated” means all subsidiaries are combined Point in time for which the balance sheet was prepared

Ownership of other companies’ stocks and bonds Amounts due from customers and others Food, beverage, and packaging supplies on hand Rent, advertising, and insurance paid in advance

Includes furniture and fixtures Cost of property and equipment at date of acquisition Amount of cost used in past operations Ownership of other companies’ stocks and bonds Rights, such as patents, trademarks, and licenses

Amount due to suppliers Unredeemed gift cards Amount due to employees Amount due for electric, gas, and telephone usage Summary of liabilities due beyond one year Total par value of stock issued by company to investors Excess of amount received from investors over par Undistributed earnings reinvested in the company

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2-7

Unrecorded but Valuable Assets and Liabilities FINANCIAL ANALYSIS

$$$ Some assets and liabilities may not be reported on the balance sheet.

Some intangible assets: Internally developed over time Not purchased Off-balance-sheet financing: Rental obligations

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2-8

What Business Activities Cause Changes in the Financial Statement Amounts?

Nature of Business Transactions External Events: Exchanges between the entity and one or more parties.

Ex: Purchase of a machine from a supplier.

Internal Events: Events that are not exchanges between parties but that have a direct and measurable effect on the entity.

Ex: Using up insurance paid in advance.

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2-9

Accounts A standardized format used by companies to accumulate the dollar effect of transactions.

Cash

Equipment

Inventory

Notes Payable

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2-10

Exhibit 2.3 Typical Account Titles

Accounts with “receivable” in the title are always assets; they represent amounts owed by (receivable from) customers and others to the business.

Prepaid Expenses is always an asset; it represents amounts paid in advance by the company to others for future benefits, such as future insurance coverage, rental of property, or advertising.

Accounts with “payable” in the title are always liabilities and represent amounts owed by the company to be paid to others in the future.

Assets Cash Short-Term Investments Accounts Receivable Notes Receivable Inventory (to be sold) Supplies Prepaid Expenses Long-Term Investments Equipment Buildings Land Intangibles

Liabilities Accounts Payable Accrued Expenses Payable Notes Payable Taxes Payable Unearned Revenue Bonds Payable

Stockholder’s Equity Common Stock Additional Paid-in Capital Retained Earnings

Accounts with “unearned” in the title are always liabilities representing amounts paid in the past to the company by others who expect future goods or services from the company.

Title expense accounts by what was incurred or used followed by the word “expense,” except for inventory sold, which is titled Cost of Goods Sold.

Revenues Sales Revenue Fee Revenue Interest Revenue Rent Revenue Service Revenue

Expenses Cost of Goods Sold Wages Expense Rent Expense Interest Expense Depreciation Expense Advertising Expense Insurance Expense Repair Expense Income Tax Expense

Title revenue accounts by their source followed by the word “revenue.”

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2-11

Principles of Transaction Analysis  Every transaction affects at least two accounts (duality of effects).

 The accounting equation must remain in balance after each transaction.

A = L + SE Assets

Liabilities

Stockholders’ Equity

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2-12

Balancing the Accounting Equation

Step 1: Ask—What was received and what was given?  Identify the accounts (by title) affected and make sure at least two accounts change.  Classify them by type of account. Was the account an asset (A), a liability (L), or a stockholders’ equity (SE) account?  Determine the direction of the effect. Did the account increase [+] or decrease *−+?

Step 2: Verify—Is the accounting equation in balance?  Verify the equality of the accounting equation (A = L + SE)

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2-13

Analyzing Chipotle’s Transactions (a) Chipotle issued 10,000 additional shares of common stock with a par value of $0.01 per share at a market value of $0.37 per share, receiving $3,700 in cash from investors.

Step 1: What was received and what was given? (account name, type of account, amount, and direction of effect)

Received:

Cash (+A) $3,700

Given: Additional stock shares: Common Stock (+SE) $100 (10,000 shares × $0.01 per share) Additional Paid-in Capital (+SE) $3,600 (10,000 shares × $0.36 per share) Assets

=

Property and Intangible Investments Equipment Assets

Cash (a) +3,700

Liabilities Notes Payable

Dividends Other Payable Liabilities

=

+

Stockholders’ Equity Common Additional Retained Stock Paid-in Capital Earnings +100

+3,600

Step 2: Is the accounting equation in balance?

Assets $3,700 = Liabilities $0 + Stockholders’ Equity $3,700

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Analyzing Chipotle’s Transactions (b) Chipotle borrowed $2,000 from its local bank, signing a note to be paid in three years.

Step 1: What was received and what was given? (account name, type of account, amount, and direction of effect)

Received:

Cash (+A) $2,000

Assets Cash (a) +3,700 (b) +2,000

Given: Long-Term Notes Payable (+L) $2,000

=

Property and Intangible Investments Equipment Assets

Liabilities Notes Payable

= =

Dividends Other Payable Liabilities

+

Stockholders’ Equity Common Additional Retained Stock Paid-in Capital Earnings +100

+3,600

+2,000

Step 2: Is the accounting equation in balance?

Assets $2,000 = Liabilities $2,000 + Stockholders’ Equity $0

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2-15

Analyzing Chipotle’s Transactions (c) Chipotle purchased $10,000 in additional land, $8,200 in new buildings, $33,800 in new equipment, and $3,700 in additional intangible assets; paid $53,400 in cash and signed a short-term note payable for the remainder owed ($2,300).

Step 1: What was received and what was given? (account name, type of account, amount, and direction of effect)

Received:

Land (+A) $10,000 Buildings (+A) 8,200 Equipment (+A) 33,800 Intangible Assets (+A) 3,700

Assets Cash (a) +3,700 (b) +2,000 (c) –53,400

=

Property and Intangible Investments Equipment Assets

+52,000

+3,700

Liabilities Notes Payable

= = =

Given: Cash (−A) $53,400 Short-Term Notes Payable (+L) 2,300

Dividends Other Payable Liabilities

+

Stockholders’ Equity Common Additional Retained Stock Paid-in Capital Earnings +100

+3,600

+2,000 +2,300

Step 2: Is the accounting equation in balance?

Assets $2,300 = Liabilities $2,300 + Stockholders’ Equity $0

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2-16

Analyzing Chipotle’s Transactions (d) Chipotle paid $2,300 on the short-term note payable in (c) above and $2,300 on other noncurrent liabilities (ignore interest).

Step 1: What was received and what was given? (account name, type of account, amount, and direction of effect)

Received:

Reduction in amount due: Short-Term Notes Payable (−L) $2,300 Other Liabilities (−L) 2,300

Assets Cash (a) +3,700 (b) +2,000 (c) –53,400 (d) –4,600

=

Property and Intangible Investments Equipment Assets

+52,000

+3,700

Liabilities Notes Payable

= = = =

Given: Cash (−A) $4,600

+

Dividends Other Payable Liabilities

Stockholders’ Equity Common Additional Retained Stock Paid-in Capital Earnings +100

+2,000 +2,300 –2,300

+3,600

–2,300

Step 2: Is the accounting equation in balance?

Assets –$4,600 = Liabilities −$4,600 + Stockholders’ Equity $0

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Analyzing Chipotle’s Transactions (e) Chipotle purchased the stock of other companies as investments, paying $44,000 cash; of this, $9,000 was in short-term investments and $35,000 was in long-term investments.

Step 1: What was received and what was given? (account name, type of account, amount, and direction of effect)

Received:

Short-Term Investments (+A) $9,000 Long-Term Investments (+A) 35,000

Assets Cash (a) +3,700 (b) +2,000 (c) –53,400 (d) –4,600 (e) –44,000

=

Property and Intangible Investments Equipment Assets

+52,000 +44,000

+3,700

Liabilities Notes Payable

= = = = =

Given: Cash (−A) $44,000

+

Dividends Other Payable Liabilities

Stockholders’ Equity Common Additional Retained Stock Paid-in Capital Earnings +100

+2,000 +2,300 –2,300

+3,600

–2,300

Step 2: Is the accounting equation in balance?

Assets $0 = Liabilities $0 + Stockholders’ Equity $0

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2-18

Analyzing Chipotle’s Transactions (f) Chipotle does not pay dividends but instead reinvests profits into growing the business. However, for illustration purposes, assume Chipotle’s board of directors declared that the Company will pay $3,000 in cash as dividends to shareholders next quarter.

Step 1: What was received and what was given? (account name, type of account, amount, and direction of effect)

Received:

Lower undistributed earnings Retained Earnings (−SE) $3,000

Assets Cash (a) +3,700 (b) +2,000 (c) –53,400 (d) –4,600 (e) –44,000 (f) –96,300

=

Property and Intangible Investments Equipment Assets

+52,000

+3,700

+44,000

Liabilities Notes Payable

= = = = =

Given: Dividends Payable (+L) $3,000 +

Dividends Other Payable Liabilities

Stockholders’ Equity Common Additional Retained Stock Paid-in Capital Earnings +100

+2,000 +2,300 –2,300

+3,600

–2,300 +3,000

+44,000

+52,000

+3,700

=

+2,000

+3,000

–3,000 –2,300

+100

+3,600

–3,000

Step 2: Is the accounting equation in balance?

Assets $0 = Liabilities $3,000 + Stockholders’ Equity −$3,000 Overall effects of (a)–( f): Assets $3,400 = Liabilities $2,700 + Stockholders’ Equity $700 $ 3,400 = $3,400 Copyright ©2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

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How Do Companies Keep Track of Account Balances?

General Journal

T-accounts

General Ledger

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2-20

Exhibit 2.4 The Accounting Cycle Start of new period

During the Period (Chapters 2 and 3) 1 Analyze transactions 2 Record journal entries in the general journal 3 Post entries to the general ledger (or T-account)

4 5 6 7

At the End of the Period (Chapter 4) Prepare a trial balance (check if debits = credits) Adjust revenues and expenses and related balance sheet accounts (record in journal and post to ledger) Prepare financial statements and disseminate them to users Close revenues, expenses, gains, and losses to Retained Earnings (record in journal and post to ledger)

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Exhibit 2.5 Basic Transaction Analysis Model

STOCKHOLDERS’ EQUITY ASSETS (many accounts) + Debit

– Credit

=

LIABILITIES (many accounts) – Debit

+ Credit

+

Contributed Capital (2 accounts)

Earned Capital (1 account)

Common Stock and Additional Paid-in Capital

Retained Earnings

+ Credit Investment by owners

– Debit Dividends declared

+ Credit Net income (expanded in Ch. 3)

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The Journal Entry

Account Titles: Debited accounts on top.

Credited accounts on bottom, usually indented. (a) Cash (+A) . . . . . . . . . . . . . . . . . . . . . . . .

Common Stock (+SE) . . . . . . . . . . . . . . .

Additional Paid-in Capital (+SE) . . . . . . . . .

Amounts: Debited amounts on left.

Credited amounts on right.

Debit 3,700

Credit 100 3,600

Reference: Letter, number, or date.

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Exhibit 2.6 Posting Transaction Effects from the Journal to the Ledger General Journal Date Account Titles and Explanation (in thousands) 1-2-15 Cash Common Stock Additional Paid-in Capital (Investment by stockholders.)

General Ledger Date Explanation Balance 1-2-15

General Ledger Date Explanation Balance 1-2-15

General Ledger Date Explanation Balance 1-2-15

Ref.

Debit

101 301 302

3,700 100 3,600

CASH Ref. G1

Ref. G1

Debit

Page G1 Credit

Credit

3,700

COMMON STOCK Debit Credit 100

101 Balance 419,500 423,200

301 Balance 400 500

ADDITIONAL PAID-IN CAPITAL 302 Ref. Debit Credit Balance 290,200 G1 3,600 293,800

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Exhibit 2.7 T-Accounts Illustrated Draw a line across the T when you are ready to compute the ending balance.

Start with a beginning balance.

+ Cash (A) – Beg. balance (a) End. balance

Use the same reference as in the journal entry.

419,500 3,700 423,200

− Common Stock (SE) + 400 100 500

Beg. balance (a) End. balance

Put the ending balance amount on the side of the T-account that it represents (e.g., + side if it is a positive number).

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Inferring Business Activities from T-Accounts FINANCIAL ANALYSIS

$$$

− Accounts Payable (L) + Cash payments to suppliers?

600

Beg. bal.

1,500

Purchases on account

300

End bal.

Solution: Beginning Purchases Cash Payments Ending Balance + on Account - to Suppliers = Balance $600

+ $1,500 $2,100

-

? ?

= $ 300 = $ 300 = $1,800

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2-26

Transaction Analysis Illustrated (a) Chipotle issued (sold) 10,000 additional shares of common stock with a par value of $0.01 per share at a market value of $0.37 per share, receiving $3,700 in cash from investors. Common Stock is recorded at par (10,000 shares × $0.01 par value per share), and Additional Paid-in Capital is recorded for the excess over par value (10,000 shares × $0.36 per share). (a) Cash (+A) . . . . . . . . . . . . . . . . . . . . . . . . . .

Common Stock (+SE) . . . . . . . . . . . . . . . . .

Additional Paid-in Capital (+SE) . . . . . . . . . . .

Assets Cash

=

Liabilities

+

+3,700

Debit 3,700

Credit 100 3,600

Stockholders’ Equity Common Stock

+100

Additional Paid-in Capital +3,600

+ Cash (A) – 1/1/15 (a)

419,500 3,700

– Common Stock (SE) + 400 100

1/1/15 (a)

Additional Paid-in – Capital (SE) + 290,200 3,600

1/1/15 (a)

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2-27

Transaction Analysis Illustrated (b) Chipotle borrowed $2,000 from its local bank, signing a note to be paid in three years. Since Notes Payable is a new account not listed on the December 31, 2014, balance sheet in Exhibit 2.2, its beginning balance is $0.

Debit (b) Cash (+A) . . . . . . . . . . . . . . . . . . . . . . . . . .

2,000 Long-Term Notes Payable (+L) . . . . . . . . . . . . . . . .

Assets Cash

= +2,000

+ Cash (A) – 1/1/15 419,500 (a) 3,700 (b) 2,000

Liabilities Long-Term Notes Payable

+

Credit

2,000

Stockholders’ Equity

+2,000

Long-Term – Notes Payable (L) + 0 2,000

1/1/15 (b)

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2-28

Transaction Analysis Illustrated After analyzing all transactions from (a)–(f), the balance in our T-accounts will appear as follows: + Short-Term Investments (A) –

+ Cash (A) – 1/1/15 (a) (b)

419,500 3,700 2,000

53,400 4,600 44,000

(c) (d) (e)

1/1/15 (e)

+ Land (A) –

338,600 9,000 347,600

1/1/15 (c)

11,100 10,000 21,100

323,200

+ Buildings (A) – 1/1/15 1,267,100 (c) 8,200 1,275,300

1/1/15 (c)

Short-Term – Notes Payable (L) + (d)

2,300

0 1/1/15 2,300 (c) 0

– Common Stock (SE) + 400 1/1/15 100 (a) 500

+ Intangible Assets (A) –

+ Equipment (A) – 442,500 33,800 476,300

1/1/15 (c)

Long-Term – Notes Payable (L) + 0 2,000 2,000

64,700 3,700 68,400

290,200 1/1/15 3,600 (a) 293,800

1/1/15 (e)

Dividends – Payable (L) +

1/1/15 (b)

– Additional Paid-in Capital (SE) +

+ Long-Term Investments (A) –

0 3,000 3,000

496,100 35,000 531,100

– Other Liabilities (L) + 1/1/15 (f)

288,200 1/1/15 (d)

2,300 285,900

– Retained Earnings (SE) + 1,721,800 1/1/15 (f) 3,000 1,718,800

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Trial Balance •

•

CHIPOTLE MEXICAN GRILL–TRIAL BALANCE

The trial balance is a listing of the ending balances in each account in the general ledger.

The purpose of the trial balance is to make sure the debits and credits are equal before we prepare the balance sheet.

(based on investing and financing transactions only during the first quarter ended March 31, 2015)

(in thousands)

Debit

Credit

Cash 323,200 Short-term investments 347,600 Accounts receivable 34,800 Supplies 15,300 Prepaid expenses 70,300 Land 21,100 Buildings 1,275,300 Equipment 476,300 Accumulated depreciation 613,700 Long-term investments 531,100 Intangible assets 68,400 Accounts payable 69,600 Unearned revenue 16,800 Dividends payable 3,000 Wages payable 73,900 Utilities payable 85,400 Short-term notes payable 0 Long-term notes payable 2,000 Other liabilities 285,900 Common stock 500 Additional paid-in capital 293,800 Retained earnings 1,718,800 Total

3,163,400 3,163,400

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Classified Balance Sheet

Current assets are those to be used or turned into cash within the upcoming year, whereas noncurrent assets are those that will last longer than one year.

Assets and liabilities are classified into two categories: current and noncurrent.

Current liabilities are those obligations to be paid or settled within the next 12 months with current assets.

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2-31

Exhibit 2.8

Chipotle Mexican Grill’s First Quarter 2015 Balance Sheet (based on investing and financing activities only)

CHIPOTLE MEXICAN GRILL, INC. Consolidated Balance Sheets (in thousands of dollars, except per share data) March 31, December 31 2015 2014 ASSETS Current Assets: Cash Short-term investments Accounts receivable Supplies Prepaid expenses Total current assets Property and equipment: Land Buildings Equipment Total cost Accumulated depreciation Net property and equipment Long-term investments Intangible assets Total assets

$ 323,200 347,600 34,800 15,300 70,300 791,200

$ 419,500 338,600 34,800 15,300 70,300 878,500

21,100 1,275,300 476,300 1,772,700 (613,700) 1,159,000 531,100 68,400 $2,549,700

11,100 1,267,100 442,500 1,720,700 (613,700) 1,107,000 496,100 64,700 $2,546,300

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2-32

Exhibit 2.8

Chipotle Mexican Grill’s First Quarter 2015 Balance Sheet (based on investing and financing activities only)

CHIPOTLE MEXICAN GRILL, INC. Consolidated Balance Sheets (in thousands of dollars, except per share data) March 31, December 31 2015 2014 LIABILITIES AND STOCKHOLDERS’ EQUITY Current Liabilities: Accounts payable Unearned revenue Dividends payable Accrued expenses payable: Wages payable Taxes payable Total current liabilities Notes payable Other liabilities Total liabilities Stockholders’ Equity: Common stock ($0.01 par value per share) Additional paid-in capital Retained earnings Total stockholders’ equity Total liabilities and stockholders’ equity

$ 69,600 16,800 3,000

$ 69,600 16,800 —

73,900 85,400 248,700 2,000 285,900 536,600

73,900 85,400 245,700 — 288,200 533,900

500 293,800 1,718,800 2,013,100 $2,549,700

400 290,200 1,721,800 2,012,400 $2,546,300

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International Perspective

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2-34

Current Ratio KEY RATIO ANALYSIS

$$$ Current Ratio =

Current Assets Current Liabilities

Does a company have the short-term resources to pay its short-term debt?

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2-35

Investing and Financing Activities FOCUS ON CASH FLOWS

Companies report cash inflows (+) and outflows (−) over a period in their statement of cash flows.

$$$

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